SM Energy: Debt Paydown Could Allow For A Major Dividend Increase

Jan. 29, 2022 2:15 AM ETSM Energy Company (SM)7 Comments

Summary

  • SM appears capable of generating $1.1 billion in positive cash flow in 2022 at current strip prices.
  • This is despite a projected hedging loss of over $450 million for 2022.
  • With SM's balance sheet greatly improved by debt paydown during 2022, it should be able to support a significant dividend increase.
  • At conservative prices of $50 oil and $2.50 gas, SM may be able to generate $3.45 per share in unhedged free cash flow.
  • Thus a $1.50 per share annual dividend would be easily supportable.
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North American Oil

mysticenergy/E+ via Getty Images

SM Energy (NYSE:SM) may end up with over $450 million in realized hedging losses in 2022 at current strip prices. Despite those projected hedging losses, it is still only hedged approximately 35% on its 2022 oil production, so it may be able to deliver $1.1 billion in positive cash flow despite those hedging losses.

At $33 to $34 per share, SM looks like quite a good value. It should be capable in the future of generating around $3.45 per share in free cash flow in a $50 WTI oil and $2.50 NYMEX gas scenario, allowing it to significantly boost its dividend after paying down its debt in 2022.

I estimate that SM can be worth in the high-$40s per share in a long-term $65 to $70 oil scenario.

2022 Outlook At Current Strip

At current strip prices of $83 WTI oil, SM is now projected to generate $2.617 billion in revenues after hedges. SM's hedges have negative $469 million in estimated value, primarily due to its oil hedges. SM has only hedged around 35% of its oil production, but that includes swaps covering around 26% of its oil production at nearly $40 below strip.

SM Energy

SM's derivative positions

sm-energy.com

SM also has natural gas hedges covering around 40% of its 2022 production and these hedges are well below strip prices as well. The oil hedges have a much greater impact on the hedging losses though.

Type Barrels/Mcf $ Per Barrel/Mcf $ Million
Oil 29,638,000 $81.50 $2,415
NGLs 5,292,500 $35.00 $185
Gas 107,967,000 $4.50 $486
Hedge Value -$469
Total $2,617

SM is now projected to generate $1.1 billion in positive cash flow in 2022, assuming that it ends up with a $750 million capital expenditure budget. It would have generated over $1.5 billion in positive cash flow without hedges.

$ Million
Lease Operating $226
Transportation $137
Production and Ad Valorem Taxes $165
Cash G&A $85
Cash Interest $152
Capex $750
Dividends $2
Total $1,517

Source: Author's Work

Debt And Leverage

SM's projected positive cash flow during 2022 would reduce its net debt to approximately $850 million by the end of the year. This would be 0.4x its 2022 EBITDAX at strip prices, which would indicate that its debt issues should largely be taken care of by the end of the year.

SM's free cash flow in a $50 WTI oil and $2.50 NYMEX gas environment is estimated at approximately $3.45 per share, assuming that it uses its positive cash flow during 2022 to repurchase debt and reduce its interest costs accordingly.

This would allow SM Energy to considerably increase its dividend. SM appears easily capable of supporting a $1.50 per share annual dividend. This should take up less than 45% of its free cash flow in an unhedged $50 WTI oil and $2.50 NYMEX gas environment if it had a roughly $750 million capital expenditure budget. Thus it could support an even larger dividend if it wanted to be more aggressive.

Valuation Notes

With SM's improved cash flow prospects for 2022, I'm bumping SM's estimated value up to $45 per share at long-term $65 WTI oil and $3.25 NYMEX gas. This would increase to around $50 per share at long-term $70 WTI oil and $3.50 NYMEX gas. This is based on a 3.5x EV/EBITDAX multiple and its year-end 2022 projected net debt.

As a check, we can look at SM's valuation using another method. If SM's production (at 145,000 BOEPD for 2022) is valued at $40,000 per flowing BOE, that would make its production worth $5.8 billion. SM also has 82,000 net acres in the Midland Basin and 155,000 net acres in South Texas. If that land was valued at another $1 billion combined, SM's total value would be $6.8 billion.

SM is projected to end 2022 with approximately $850 million in net debt. SM's 2023 hedges also have around negative $35 million in value. Adjusting for these items results in an estimated market capitalization of $5.915 billion for SM Energy. This is approximately $47.75 per share based on SM's diluted share count.

Thus a one-year target in the high-$40s appears reasonable for SM Energy.

Conclusion

SM Energy is on track to generate approximately $1.1 billion in positive cash flow in 2022. This would put its balance sheet in quite good shape and would put it into position to significantly increase its dividend. A $1.50 per share annual dividend would be easily sustainable, even if based on more conservative prices such as $50 WTI oil and $2.50 NYMEX gas.

At my current longer-term expectations of $65 to $70 WTI oil, SM Energy's value should be in the high $40s. At those oil prices, SM may be able to generate $8+ per share in unhedged free cash flow.

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