Metro State University of Denver Sector: Energy

SM Energy Company Industry: Oil & Gas E&P

Ticker – NYSE: SM Valuation Date: January 16th, 2019 Recommendation: BUY

Key 2018 2019 2020 2021 2022 2023

Market Profile Financials

Net Income (29,158) 25,278 177,608 262,569 341,692 386,059

Current Price $20.02
52- wk range $13.15 - $33.76 EBITDAX 851,368 858,671 1,130,728 1,304,266 1,424,791 1,527,416
Average Daily
2,832,441
Volume EPS $(0.26) $0.23 $1.59 $2.34 $3.05 $3.45

Shares Out 112,140

P/E (76.90) 88.70 12.62 8.54 6.56 5.81
Market Cap $2,245,042.80
Enterprise Value $4,497,884.00 P / Cashflow 4.36 2.70 2.92 2.26 1.96 1.77
DPS $0.10
Dividend Yield 0.50% EV/EBITDAX 5.28 5.24 3.98 3.45 3.16 2.94

Target Price $36.51

Source: FactSet & Student Research
Highlights
● We recommend buying SM Energy with a
target price of $36.50, an 80% upside from
its current price
● We think the company can reap the
rewards of a major overhaul of its
portfolio over the last 2 years. In the last
two years, SM divested assets that it did not
see as essential to its growth. Using the
proceeds plus debt, SM completed two large
acquisitions of largely unproven acreage in
core areas of the Midland Basin. We
believe the market is not giving the
company credit for the potential of these
assets.
● Equity holders will benefit from
deleveraging. We forecast the company will
accrue enough cash to pay $1.5 billion in
debt in the coming years, a present value of
almost $12 per share to equity holders.
Source: Student Research
• High commodity price sensitivity: As with
all E&P Firms, SM faces commodity price
risk but it is especially acute given its
leverage and aggressive plans to develop its
recently acquired acreage. An extended
period of oil below $50 challenges its
growth plans and the balance sheet pressure
intensifies with a sustained period of low
prices.
Business Description
As recently as 2016, the majority of the Company’s
revenue was coming from outside of the Permian
Basin; however, a series of acquisitions and
divestitures in the second half of 2016 solidified SM
as an established player in the Permian Basin. We
believe that, despite the high debt levels and
weakening oil market, these acquisitions have set
the company up for long-term success.
Management’s current focus is to invest to develop
its newly acquired assets while still being able to

1
pay down debt. While the company projects mid-
2019 to begin generating cash flow after capex, we
think the weak oil market pushes the crossover into
2020. We believe, however, that the company
maintains the resources to continue to grow
production.
Through three quarters in 2018, production of oil
generated 65.5% of revenue, gas production
revenue was 20.9%, and NGL production made up
the remaining 13.6%. In 2017, the revenue split
was 52.2% oil, 29.5% gas, and 18.3% NGL. This
shift to oil revenue reflects the increased focus on
the oil-rich Permian play, the divestitures of non-
core properties in the Rocky Mountains, and the
decreased capital expenditures towards gas-heavy
Eagle Ford. We expect a continued shift to oil.
Source: Student Research
As of December 31, 2017, SM held leases for
85,382 net acres in the Midland Basin and 162,853
net acres in Eagle Ford with 36.6% and 56.9% of
these acres being undeveloped
respectively. Through nine months in 2018, the
Company acquired 3,400 net acres of primarily
unproved properties in the Midland Basin as well as
completing acreage trades which resulted in a net
gain of 700 primarily unproved properties in the
Midland Basin. Thus, the acreage position in the
Midland Basin as of September 30, 2018 increased
to 89,482 net acres while the holdings in the Eagle
Ford region did not change.
Source: Company Data
The last reported reserve estimates from the end of
2017 showed total proved reserves of 468.1
MMBOE with 54% of those reserves being proved
undeveloped. In 2018, however, the company
divested properties accounting for 4.2 MMBOE of
the total proved reserve quantities in the Powder
River Basin. Thus, we estimate 463.9 MMBOE of
proved reserve quantities. It is important to note
that these are only proved reserve quantities and do
not account for the largely unproved properties that
the Company holds in the Midland Basin, which
have a current book value of $1.89 billion as of
September 30, 2018.
Because SM is exclusively focused on the
exploration and production of oil, gas, and NGLs,
its primary customers are the midstream processing
companies that are also operating in the Midland
and Eagle Ford regions. The Company has four
contract types for the sale of its oil, gas, and NGLs.
With the sale of oil, the control of the commodity
transfers at the well head as oil is sold directly to a
purchaser who pays an agreed-upon price that is net
of adjustments based on quality and transportation
costs for the purchaser. The sale of gas is more
complicated and control of the product can transfer
anywhere from the well head to some point
downstream after final processing depending on the
terms of the contract and therefore, each contract
has different requirements as far as the payment of
processing and transportation costs for the
NGLs. In the fourth quarter of 2018, a lack of
pipeline infrastructure in the Midland Basin
widened the spread between the WTI market price
of oil and the price that the company was able to
realize. The issue is expected to be resolved in the
first quarter of 2019; however, should the
midstream infrastructure continue to be inadequate
moving forward, this will lead to a significant
decrease in the cash flow of the Company.
Investment Summary
Business Strategy
The Company has largely completed the portfolio
switch that was set in motion in 2016 with the QStar
and Rock Oil acquisitions and the divestitures of
certain Williston Basin assets. As such, the strategy
for the company moving forward centers around
developing and maximizing value in its remaining
Midland Basin and Eagle Ford assets.
The current strategy of the company has the
following three pillars:
● Optimizing the portfolio. The company is
investing heavily in the Permian, where it
sees the most opportunity, projecting 20%
growth in production for that production. At
the same time, the company currently
anticipates essentially flat production from
Eagle Ford.
● Generating high margins and returns –
By improving its portfolio, the company can
improve the efficiencies in its operations,
generate growth and improve returns. The
company wants to reduce capital costs per
well and production expenses. Accordingly,
we forecast greater capital expenditure
efficiency and higher returns on equity.
Source: Student Research
● Improving its balance sheet - SM Energy’s
debt load is high. Debt to EBITDA is 2.65 in
2018; however, we believe the company can
reduce this to 0.58 by 2023. The company
has $476.8 million in 6.125% Senior Notes
due in 2022, which we believe the company
will be able to pay off. In the next five years,
the company will be able to reduce debt
without sacrificing its capex plans. Should
oil remain depressed, however, the
company’s growth strategy will need to be
replaced with more aggressive balance sheet
restructuring, which could be dilutive to
equity holders. We believe that management
will be able to consistently and drastically
reduce their net debt over the next few
years. We also note the company’s debt has
not traded off significantly more than its
peers in the recent weak period for oil.
Source: Student Research & Company Data
Source: Student Research & Company Data
Growth Potential
With the large acquisitions that SM undertook in the
Permian Basin in 2016, we believe that the
company is poised for explosive growth over the
coming years. Currently, the Permian Basin is the
largest source of oil production for onshore US
E&P companies, more than doubling the daily oil
production of any of the other large plays in the
continental US. Additionally, the Permian Basin
and Eagle Ford plays are the second and third
largest sources of natural gas respectively. SM still
maintains a large number of acres in the Eagle Ford
area and will be able to use this position to diversify
its production mix. SM also currently maintains a
joint venture in the Eagle Ford area which is
allowing it to explore the use of new technology for
potentially greater future upside without the risk of
utilizing unknown technology. In the same vein,
the company has shown in recent quarters that it is
improving its well efficiencies. Management has
stated that they foresee a production growth of 20%
in the Permian Basin year-over-year in 2019 while
simultaneously reducing their capital expenditures
by upwards of 15%. Such improvements in
efficiency will undoubtedly drive a significant
growth in cash flow over the coming years.
Management and Ownership
SM’s management team consists of engineering-
minded individuals, finance professionals, and
management professionals who are proven leaders.
The CEO, Jay Ottoson, assumed the position in
February of 2015 after serving as COO since
December of 2006. Ottoson holds a Bachelor of
Science degree in chemical and petroleum refining
engineering from Colorado School of Mines and
has worked exclusively in the oil and gas industry
since he received his degree in 1980. Under his
direction, the company utilized the proceeds from
its divestitures of non-core assets, the recently
buoyed oil markets and low interest rates to shift the
focus from a split portfolio spanning much of the
United States to a more condensed portfolio that
focuses heavily into the Permian Basin. Every
member of the company’s management team has an
extensive background in the industry. We believe
that the vision of current management is one that
will lead to sustainable long-term growth for the
company.
During 2018, there has been no major change in the
stockholder structure of the company. The largest
five shareholders own 36.3%. Listed in order from
largest to smallest, they are Vanguard Group,
Blackrock, Capital Research Global Investors,
Dimensional Fund Advisors, and Encap Energy
Capital Fund.
Source: Nasdaq Data
Industry Overview & Competitive
Positioning
Outlook on Commodity Price
With $55 per barrel and $3.00 MMBtu
expectations, we are incorporating essentially flat
expectations for oil and gas prices in our financial
forecasts and valuations. We project NGLs trading
with their traditional relationship to oil. Clearly,
SM’s stock prices are inexorably tied to oil prices.
The stock fell sharply with oil in 4Q 2018.
OPEC has announced that it will be reducing their
production by approximately 1.2 million barrels per
day for the first six months of this year, We think
expected OPEC reductions, a Saudi need for higher
oil, and growing demand in emerging markets could
support demand, while U.S. shale economics
suggest supply constraints if oil fell below current
levels. We see challenged economics to SM’s
growth plans and to those of its U.S. competitors
below $50. We also think the forward curve makes
hedging less attractive, putting more pressure on
U.S. supply should oil fall from here for an
extended period.
Other factors favorable to SM’s product mix
include:
Expanding NGL market: Plastics are reported to
increase production by 33%. Nearly all the ethane
produced from NGLs goes towards feedstock of
plastics. As plastic demand increase, so should
demand for other chemicals that can be produced
from the hydrocarbons in NGL mixtures.
Lighter crude premium returns: Lighter crude
has been selling at a discount to WTI but we think
the more typical premium can return.
Competitive Positioning As a result of increased focus on the Permian Basin
While small in a global sense, SM has adequate at the expense of the Eagle Ford region, we assume
scale in the areas where it drills to obtain that production from the Permian as a percentage of
competitive supply contracts, including service and total production is going to increase from 51% in
supplies. It size allows it to operate with industry- 2018 to almost 82% by 2023.
level or better efficiency. SM has developed long-
term and attractively priced relationships with its
suppliers. It also has adequate access to capital
markets to fund its acquisitions and secure its
balance sheet if needed. The competitive
positioning for SM is neither a significant factor nor
benefit.

Financial Analysis
Production Profile Assumptions
According to management’s guidance, they are
expecting to drive an increase in production through
increased focus on longer laterals in the Permian
Basin. In line with this guidance, we assume that
SM will maintain 103 wells per year over the next
five years with daily production improving by 20%,
15%, and 5% in 2019, 2020, and 2021 respectively
before leveling off at 1,881 bbl/day for 2022 and
2023. Management also believes that they will be
maintaining a relatively consistent production
schedule in the Eagle Ford region and we therefore
held the expected number of wells constant as well
as the daily production rates constant in that region
for the next five years. We also assume a constant
annual new-well decline rate in the Permian of 63%
consistent with industry standards for the region.
We assume that decline rates for existing wells will
slowly decrease over the coming years at a constant
rate of approximately 2.5% as more SM’s inventory
of existing wells ages and approaches the mature
decline rate of 14%. This number is held closer to
the new-well decline rate because SM just began its
drilling in 2017.
Source: Student Research & Company Data
The capital expenditure per well for 2018 was
determined by taking the capital expenditures
through the first nine months and dividing it by the
number of wells drilled in 2018. From there, we
used management’s guidance that they anticipate a
decrease in Capital Expenditures of 15% from 2018
to 2019 while maintaining approximately the same
size program in both regions in terms of number of
completions. Instead of crediting the full 15% to
this value in 2019 alone, we credited the company
with a 10% decrease in 2019 as well as 2020
assuming improved efficiency moving forward as
well. We decreased the rate to 5% in 2021 before
leveling it off in 2022 and 2023 as this brought the
company below the lower estimates for this value
throughout the Permian. We believe the value is
still reasonable considering the company’s
commitment to improving their technology and
methods.

As for the Eagle Ford region, the decline rate for

new wells is also a constant, although the decline
rates in this region are slightly lower at 60%. The
methodologies used to determine the decline rates
for existing wells in Eagle Ford are almost identical
to those used for the Permian; however, SM’s
decreased focus along with their larger inventory of
mature wells in the region led us to assume a much
lower decline rate for existing wells.
Source: Student Research & Company Guidance
Oil price assumptions
For the purpose of our DCF valuation, we assume a
constant oil price of $55/Bbl, a natural gas price of
$3/Bcf, and an NGL price of $26.12/Bbl (a 47%
discount from the price of oil). We also assume that
SM realizes a constant $6 discount on oil, no
discount on natural gas, and a $5 discount on NGL
prices compared to market price before
hedging. As a result of their hedging program, we
assume that the Company ultimately realizes 96%,
100%, and 85% of the pre-hedge price on oil,
natural gas, and NGLs respectively. All of the
assumptions for discounts and the Company’s
hedging program were informed by past
performance according to their annual and quarterly
reports.
Revenue and expense assumptions
In translating the above assumptions into revenue,
we assumed that the Permian Basin will have a
production mixture of 80% oil, 20% natural gas,
and 0% NGLs whereas the Eagle Ford region will
have a mixture of 3% oil, 59% natural gas, and 38%
NGLs, consistent with the firm’s past performance.
For the expense items, Production Expenses are
broken into Lease Operating Expenses (LOE),
Transportation Costs, Production Taxes, and Ad
Valorem Tax Expense. Each of these production
costs, along with DD&A and G&A are stated
quarterly on a per BOE basis.
● The LOE per BOE metric is informed by the
most recent guidance update as of
November 1, 2018 and was lowered to $4.75
for the whole year 2018. We believe that
this is sustainable moving forward and thus
kept it as a constant in our projections.
● For the company overall, the Transportation
Costs line appears to be trending down year-
over-year; however, we feel that the average
transportation costs realized in 2018 are
sustainable on a per BOE basis into the
future and thus have kept this as a constant
as well.
● Management has stated that the Production
Tax Expense is a fixed 4.25% of Production
Revenue each year and therefore this is the
figure that we have used.
● Through nine months in 2019, the Ad
Valorem Tax Expense has been $0.51 per
BOE; however, this expense was only $0.34
per BOE in 2017 so we assume that it
remains at $0.50/BOE in the projections.
● In the updated guidance given on November
1, 2018, management updated this figure to
range from $15-$15.25 per BOE for the full
year to reflect higher costs in the second half
of the year. As such, we believe that a
constant $15/BOE is an appropriate figure
moving forward.
● As for G&A, we used the Company’s
historical average since 2013 and assumed
this to be constant over the next five years.
● We also assumed that SM would realize no
Derivative Settlement Gain or Loss over the
next five years.
● Since all of these expenses are listed on a
per BOE basis, all we did to translate them
to the Income Statement was to multiply by
the total production of the company on an
equivalent basis.
Source: Company Data
The Company’s debt metrics are projected to
improve significantly in the coming years as they
continue to grow operations and generate operating
cash flow well beyond CapEx. In addition to
paying off all of their 2022 notes with cash on hand,
we project that SM will have an additional $1.2
billion in cash by the end of 2023 that could
potentially be used to further decrease their
outstanding long-term debt should they choose.
The Company could also opt to instead funnel this
cash into more acquisitions to increase their already
strong position in the Permian or Eagle Ford
regions.

Source: Student Research & Company Data
Valuation
In valuing SM energy, we used the Discounted
Cash Flow, comparable company values and an
asset value approach.
DCF
For the DCF valuation, we assume a 2% terminal
growth rate, 23% tax rate and a WACC of
9.60%. This WACC calculation is based on the
market yields of the company’s debt and an equity
market beta of 1.6. Together, we get a value of
$36.51.
Comparisons
The companies we used for comparable company
values were screened on the basis of same industry
classification, geography (operates in the Permian),
size (employees, asset and revenues), and earnings.
All companies on the list are SIC 1311, operational
focus in the Permian basin, with similar size
structure and earnings. We focus on a median
EV/EBITDA of 6.07 for the group, compared to 4.7
for SM. Using the median, we get a target price of
$26.46.
Asset Value
We also value based on acreage and going
transaction values. Recent transactions in the
Permian have averaged around $35,000 per acre
while Eagle Ford deals were about $10,000. There
is naturally a wide range of prices and assets
quality. Using these rough measures and applying
them to SM acreage, we find a share price of $21
per share. We view this number as a floor rather
than a target value.
Stock Price History
The 52-week high for SM Energy peaked at $33.76
on Oct 1, 2018 following a steady rate of growth
beginning in June 2018. Recently, the stock price
for SM Energy has been suffering as the price of oil
and fear of sustained oversupply in the economy has
scared off many investors. This sentiment dried out
just before year end, resulting in a low of $14.48 on
12-17-18. Entering the new year, market sentiment
has been positive. The closing 2018 market price
was $15.48; however, since then, SM has
experienced nearly 30% growth in per share value
to date, a sign that markets might be recognizing
SM’s value. SM has had its ups and downs in
relation to stock price over the years. In 2008 the
financial crisis more than halved the value of the
stock; the 2012 oil crisis did much the same. While
it’s important to note that SM is a very different
company than it was during those crashes, the fact
remains the same that low oil prices will result in a
lower projection of company value.
Investment Risks
Market Risk: Fluctuations of oil, gas and NGL
prices
Valuation Scenarios
EV/2019 EBITDA DCF Result Probability
$45 oil 7.55 $ 0.43 10%
$55 oil 5.24 $ 16.15 50%
$65 oil 4.01 $ 72.59 30%
$75 oil 3.25 $ 108.00 10%
Probability Weight $ 40.70
Note: Price probabilities reflect our view of an upward bias in oil prices
Market Risk: OPEC influencing oil prices
The Organization of Petroleum Exporters Countries
can control oil prices through its strategy. OPEC’s
strategy is called pricing-over-volume. The cartel
uses the absence of sources of energy and lack of
viable economic alternatives to influence the price
of oil. OPEC has the lowest barrel production costs
and has three quarters of the world's oil reserves.
This is starting to swing back to the US free market
with the newer horizontal drilling in the Permian
Basin.
Political Risk:
Uncertainty at home and abroad as to the U.S.’s
relation to the Middle East (the world’s largest oil
producing area), the rampant inflation in Venezuela
and President Trump’s tenuous relationship with
Russia give investors the world over second
thoughts about being involved in the oil market. It’s
important to note that these key oil producing hubs
need to prosper if the price of oil (and SM as a
result) wishes to prosper.
Economic Risk: Quality of Product
In general lighter crude oil is a better quality
product. Lighter crude oil takes less processing to
acquire the products produced by crude
oil. However, recently in the Permian basin some
of the crude oil produced has be lighter than
previously discovered and it was selling at a
discount to standard light crude oil.
Operational Risk: Weather
Drilling and completion of wells are exposed to
weather related events. Large amounts of rain can
cause operations to shut down due to equipment
getting stuck, water affecting drilling and
completion in the well, safety for their
workers. Weather events like hurricanes can also
affect the midstream and downstream companies
that SM energy relies on. Hurricanes in Houston
can force refineries supplied by SM to shut down
for periods of time.
Operational Risk: Service Cost
We expect the company will maintain or reduce its
costs per BOE. Should costs spike because of price
increases from service providers or from supply
issues, the company would see pressure on
profitability and cash flow. In addition, should the
midstream infrastructure continue to be inadequate
moving forward, the company will see a significant
decrease in the cash flow. Barring a natural disaster,
however, most cost increases tend to accompany
higher commodity prices (and higher oil services
demands), thus offsetting the pressure on cash flow.
Corporate Governance
Overall, we rate SM Energy as high with respect to
its corporate governance. It maintains a high
standard of ethics within the company and with
regard to the environment and communities in
which it operates.
Beginning in 2017, SM Energy published its
inaugural Responsibility Report to demonstrate a
commitment to strong corporate governance,
transparency, and accountability in their
practices. Via a company called Ethicspoint, SM
established an anonymous hotline which allows any
employee, contractor, or director to report observed
or suspected violations of laws or company
policies. Additionally, the company has an
established code of ethics in which all of its
employees must operate, which was established by
the board of directors’ ethics committee. To
objectively estimate the SM Energy reserves, the
Company engaged Ryder Scott Company, L.P. to
audit at least 80% of its estimated proved reserves.
SM has shown an improvement in recent years with
regard to its Total Recorded Incident Rate (TRIR)
for their contractors, demonstrating that the
company’s focus on safety for all individuals
involved in its operations. As for its employee
TRIR, this value has remained consistently low over
the years. To this end, the Company maintains a
“Stop Work Authority”, which empowers any
employee or contractor to stop any work they
believe is being conducted in an unsafe manner on
all properties and rigs which SM operates.
As for their environmentally-conscious focus, SM
joined the API Environmental Partnership in
2017. This partnership is a national trade
association that focuses on developing best
practices for the energy industry with regard to
protecting the environment. SM is also constantly
looking to update its technology in order to reduce
its impact on the environment. To this end, the
company has recently been updating its pneumatic
device technology to utilize instrument air systems
in the Permian and solar-powered electronic
controllers in their South Texas region while also
utilizing real-time data and predictive analytics
along with 24-hour monitoring to ensure a safer and
more controlled drilling procedure. In addition to
being environmentally conscious, the Company is
also socially conscious and goes to great lengths to
invest in the communities in which it operates,
including charitable giving programs and a
corporate match for qualifying charities with a
focus on education, civic and community service, as
well as health and human services.
Appendix A: Financial Statement Analysis

Appendix A1:

Balance Sheet ($000's) 2016 2017 2018E 2018E 2018E 2018E 2018E 2018E
Assets
Cash and cash equivalents 9,372 313,943 194,449 29,802 183,871 527,572 498,164 1,058,129
Accounts receivable 151,950 160,154 147,159 147,159 147,159 147,159 147,159 147,159
Derivative asset 54,521 64,266 107,654 107,654 107,654 107,654 107,654 107,654
Prepaid expenses and other 8,799 10,752 13,334 13,334 13,334 13,334 13,334 13,334
Total current assets 224,642 549,115 462,596 297,949 452,018 795,719 766,311 1,326,276
Proved oil and gas properties 5,700,418 6,139,379 6,377,474 6,624,803 6,881,723 7,148,607 7,425,842 7,713,828
Less - accumulated depletion, depreciation, and amortization (2,836,532) (3,171,575) (3,239,047) (3,364,662) (3,495,149) (3,630,697) (3,771,501) (3,917,766)
Unproved oil and gas properties 2,471,947 2,047,203 1,972,433 1,900,395 1,830,987 1,764,114 1,699,684 1,637,607
Wells in progress 235,147 321,347 317,836 317,836 317,836 317,836 317,836 317,836
Oil and gas properties held for sale, net 372,621 111,700 - - - - - -
Other property and equipment, net of accumulated depreciation 137,753 106,738 119,736 119,736 119,736 119,736 119,736 119,736
Other - - - - - - - -
Total property and equipment, net 6,081,354 5,554,792 5,548,433 5,598,108 5,655,134 5,719,598 5,791,598 5,871,242
Derivative asset 67,575 40,362 - - - - - -
Restricted Cash - - - - - - - -
Other noncurrent assets 19,940 32,507 26,888 26,888 26,888 26,888 26,888 26,888
Total other noncurrent assets 87,515 72,869 26,888 26,888 26,888 26,888 26,888 26,888
Total Assets 6,393,511 6,176,776 6,037,917 5,922,944 6,134,039 6,542,204 6,584,796 7,224,405

Liabilities
Accounts payable and accrued expenses 299,708 386,630 450,000 450,000 450,000 450,000 450,000 450,000
Current portion of Senior Notes - - - - - - - -
Derivative liability 115,464 172,582 229,287 229,287 229,287 229,287 229,287 229,287
Other Current Liabilities - - - - - - - -
Total current liabilities 415,172 559,212 679,287 679,287 679,287 679,287 679,287 679,287
Revolving credit facility - - - - - - - -
Senior Notes, net of unamortized deferred financing costs 2,766,719 2,769,663 2,447,290 2,447,290 2,447,290 2,447,290 1,947,290 1,947,290
Senior Convertible Notes 130,856 139,107 145,662 - - - - -
Asset retirement obligation 96,134 103,026 93,112 93,112 93,112 93,112 93,112 93,112
Asset retirement obligation (properties held for sale) 26,241 11,369 - - - - - -
Net Profits Plan liability - - - - - - - -
Deferred income taxes 315,672 79,989 - - - - - -
Derivative liability 98,340 71,402 79,129 79,129 79,129 79,129 79,129 79,129
Other noncurrent liabilities 47,244 48,400 45,838 45,838 45,838 45,838 45,838 45,838
Other 194,485 211,096 255,783 412,579 624,679 889,429
Total noncurrent liabilities 3,481,206 3,222,956 3,005,516 2,876,465 2,921,152 3,077,948 2,790,048 3,054,798
Stockholders' equity:
Common stock, $0.01 par value 1,113 1,117 1,121 1,121 1,121 1,121 1,121 1,121
Additional paid-in-capital 1,716,556 1,741,623 1,741,623 1,741,623 1,741,623 1,741,623 1,741,623 1,741,623
Treasury Stock - - - - - - - -
Retained earnings 794,020 665,657 625,299 639,377 805,785 1,057,154 1,387,646 1,762,505
Accumulated other comprehensive loss (14,556) (13,789) (14,929) (14,929) (14,929) (14,929) (14,929) (14,929)
Total stockholders' equity 2,497,133 2,394,608 2,353,114 2,367,192 2,533,600 2,784,969 3,115,461 3,490,320
Total Liabilities and Stockholders' Equity 6,393,511 6,176,776 6,037,917 5,922,944 6,134,039 6,542,204 6,584,796 7,224,405
Appendix A2:

Income Statement ($000's) 2016 2017 2018E 2019E 2020E 2021E 2022E 2023E
Operating revenues
Oil, gas, and NGL production revenue 1,178,426 1,253,783 1,593,944 1,626,180 1,967,637 2,196,548 2,360,077 2,502,555
Net gain (loss) on divestiture activity 37,074 (131,028) - - - - - -
Other operating revenues 1,950 6,621 4,352 4,352 4,352 4,352 4,352 4,352
Total operating revenues and other income 1,217,450 1,129,376 1,598,297 1,630,533 1,971,989 2,200,901 2,364,429 2,506,907

Operating expenses
Oil, gas, and NGL production expense 597,565 507,906 511,311 535,744 601,022 653,975 693,595 730,431
DD&A 790,745 557,036 725,972 682,270 756,496 819,695 867,463 912,469
Exploration 65,641 56,179 60,910 58,545 59,727 59,136 59,432 59,284
Impairment of proved properties 354,614 3,806 - - - - - -
Abandonment and impairment of unproved properties 80,367 12,272 43,365 43,365 43,365 43,365 43,365 43,365
General and administrative 126,428 120,585 114,667 117,533 120,472 123,483 126,571 129,735
Change in Net Profits Plan liability - - - - - - - -
Derivative (gain) loss 250,633 26,414 - - - - - -
Other operating expenses 10,772 13,667 16,676 16,676 16,676 16,676 16,676 16,676
Total operating expenses 2,276,765 1,297,865 1,472,901 1,454,132 1,597,757 1,716,330 1,807,101 1,891,959
Income (loss) from operations (1,059,315) (168,489) 125,396 176,401 374,232 484,571 557,328 614,948

EBITDA (202,929) 444,726 851,368 858,671 1,130,728 1,304,266 1,424,791 1,527,416

Non-operating income (expense)

Interest income - -
Interest expense (158,685) (179,257) (146,837) (146,837) (146,837) (146,837) (116,837) (116,837)
Gain (loss) on extinguishment of debt 15,722 (35) (26,722) - - - - -
Other, net 362 3,968 3,265 3,265 3,265 3,265 3,265 3,265
Income (loss) before income taxes (1,201,916) (343,813) (44,898) 32,829 230,660 340,999 443,756 501,376

Income tax (expense) benefit 444,172 182,970 15,740 (7,551) (53,052) (78,430) (102,064) (115,316)
37.0% 53.2% 35% 23% 23% 23% 23% 23%
Net income (loss) (757,744) (160,843) (29,158) 25,278 177,608 262,569 341,692 386,059
Share Outstanding 112,000 112,000 112,000 112,000 112,000 112,000
EPS $ (0.26) $ 0.23 $ 1.59 $ 2.34 $ 3.05 $ 3.45
DPS $ 0.10 $ 0.10 $ 0.10 $ 0.10 $ 0.10 $ 0.10

Source: Student Research & Company Data

Appendix A3:

Cash Flow Statement ($000's) 2016 2017 2018E 2019E 2020E 2021E 2022E 2023E
Cash flows from operating activities
Reconciliation of net loss to net cash provided by operating activities:
Net Income (757,744) (160,843) (29,158) 25,278 177,608 262,569 341,692 386,059
Net (gain) loss on divestiture activity (37,074) 131,028 - - - - - -
DD&A Accretion 790,745 557,036 725,972 682,270 756,496 819,695 867,463 912,469
Exploratory dry hole expense (16) 2,381 - - - - - -
Impairment of proved properties 354,614 3,806 - - - - - -
Abandonment and impairment of unproved properties 80,367 12,272 43,365 43,365 43,365 43,365 43,365 43,365
Impairment of other property and equipment - - - - - - - -
Stock-based compensation expense 26,897 22,700 23,573 - - - - -
Change in Net Profits Plan liability - - - - - - - -
Derivative (gain) loss 250,633 26,414 - - - - - -
Derivative settlement gain 329,478 21,234 (110,079) - - - - -
Amortization of deferred financing costs 9,938 16,276 13,729 13,729 13,729 13,729 13,729 13,729
Non-cash (gain) loss on extinguishment of debt, net (15,722) 35 26,722 - - - - -
Deferred income taxes (448,643) (192,066) 60,672 - - - - -
Plugging and abandonment (6,214) (2,735) - - - - - -
Other, net (3,701) 8,239 3,511 3,511 3,511 3,511 3,511 3,511
Changes in current assets and liabilities:
Accounts Receivable (10,562) 13,997 12,995 - - - - -
Refundable income taxes - - - - - - - -
Prepaid expenses and other 8,478 (1,953) 755 - - - - -
Accounts payable and accrued expenses (53,210) 44,985 63,370 - - - - -
Accrued derivative settlements 34,540 12,584 (3,579) - - - - -
Net cash provided by operating activities 552,804 515,390 831,848 768,153 994,709 1,142,869 1,269,760 1,359,133

Cash flows from investing activities

Net proceeds from the sale of oil and gas properties 946,062 776,719 743,199 - - - - -
Capital expenditures (629,911) (888,353) (1,300,000) (921,600) (829,440) (787,968) (787,968) (787,968)
Acquisition of proved and unproved oil and gas properties (2,183,790) (89,896) (24,571) - - - - -
Acquisition deposit held in escrow - - - - - - - -
Other, net - - - - - - - -
Net cash used in investing activities (1,867,639) (201,530) (581,372) (921,600) (829,440) (787,968) (787,968) (787,968)

Cash flows from financing activities

Proceeds from credit facility 947,000 406,000 - - - - - -
Repayment of credit facility (1,149,000) (406,000) - - - - - -
Debt issuance costs related to credit facility (3,132) - (4,771) - - - - -
Net proceeds from Senior Notes 491,640 - 492,079 - - - - -
Cash paid to repurchase Senior Notes (29,904) (2,344) (844,984) - - (500,000) -
Cash paid for extinguishment of debt - (13) - - - - - -
Net proceeds from Senior Convertible Notes 166,617 - - - - - - -
Cash paid for capped call transactions (24,195) - - - - - - -
Proceeds from sale of common stock 938,268 2,623 1,881 - - - - -
Dividends paid (7,751) (11,144) (11,200) (11,200) (11,200) (11,200) (11,200) (11,200)
Net share settlement from issuance of stock awards (2,354) (1,240) - - - - - -
Other, net - (171) (2,975) - - - -
Net cash provided by financing activities 1,327,189 (12,289) (369,970) (11,200) (11,200) (11,200) (511,200) (11,200)

Net change in cash and cash equivalents 12,354 301,571 (119,494) (164,647) 154,069 343,701 (29,408) 559,965
Cash and cash equivalents at beginning of period 18 12,372 313,943 194,449 29,802 183,871 527,572 498,164
Cash and cash equivalents at end of period 12,372 313,943 194,449 29,802 183,871 527,572 498,164 1,058,129

Source: Student Research & Company Data

Appendix A4:

Key Financial Ratios 2016 2017 2018E 2019E 2020E 2021E 2022E 2023E
Liquitidy Ratios
Current Ratio 0.54 0.98 0.68 0.44 0.67 1.17 1.13 1.95
Quick Ratio
Cash Ratio 0.02 0.56 0.29 0.04 0.27 0.78 0.73 1.56
Efficiency Ratios
Total asset Turnover 0.18 0.20 0.26 0.27 0.27 0.30 0.33 0.33
Fixed Asset Turnover 0.14 0.15 0.18 0.18 0.18 0.21 0.23 0.24
ACC Receivable turnover 7.76 7.83 10.83 10.83 11.05 13.37 14.93 16.04
Profitability Ratios
Gross Profit Margin 49.3% 59.5% 67.9% 67.9% 67.1% 69.5% 70.2% 70.6%
EBIT Margin 6.8% 53.7% 61.4% 61.4% 60.8% 64.2% 65.6% 66.3%
EBITDA Margin 81.8% 29.7% -16.7% 39.4% 53.3% 52.7% 57.3% 59.3%
Net Profit Margin -62.2% -14.2% -1.8% -1.8% 1.6% 9.0% 11.9% 14.5%
ROA -12.6% -2.6% -0.5% 0.4% 2.9% 4.1% 5.2% 5.6%
ROE -34.8% -6.6% -1.2% 1.1% 7.2% 9.9% 11.6% 11.7%
ROE ex cash -35.0% -7.5% -1.3% 1.1% 7.8% 12.3% 13.9% 17.2%
Solvency Ratios
Debt to Equity Ratio 1.39 1.35 1.28 1.22 1.15 1.11 0.90 0.88
Net Debt to EBITDA -13.59 5.52 2.65 2.82 2.00 1.47 1.02 0.58
Financial Leverage
Interest Coverage Ratio 20.93 3.61 -1.28 2.48 5.80 5.85 7.70 8.88
Cash Flow Ratios
Cash flow to debt ratio 0.16 0.16 0.28 0.27 0.34 0.37 0.46 0.44

Source: Student Research & Company Data

Appendix B: Valuation Methods

Appendix B1: DCF Valuation

Year: 2019 2020 2021 2022 2023

Operating Income 176,401 374,232 484,571 557,328 614,948
Depreciation and Amortization 682,270 756,496 819,695 867,463 912,469
Cap Ex (ex acquisitions) (921,600) (829,440) (787,968) (787,968) (787,968)
Working Capital - - - - -
Pre Tax Cash Flow (62,929) 301,288 516,298 636,823 739,448
Tax Rate 23% 23% 23% 23% 23%
After Tax Cash Flow (48,456) 231,992 397,549 490,354 569,375

Present Value of Free Cash Flows: 1,150,656 Terminal Value 8,216,960

Present Value of Terminal Value: 5,195,279
Enterprise Value 6,345,935 WACC Calculation 9.60%
Cost of Debt 5.01%
Net Debt (2,252,841) Cost of Equity 14.20%
Equity Value 4,093,094 Risk Free 3%
Risk Premium 7%
Shares Out 112,114 Beta 1.6
Estimated Intrinsic Stock Price: $ 36.51 Long Term Growth 2.50%

Source: Student Research & Company Data

Appendix B2: Acreage Valuation

Per Acre Acres Value

Permian 35,000 85,382 2,988,370
Eagle Ford 10,000 162,853 1,628,530

4,616,900 Acreage Value

(2,252,841) Net Debt
2,364,059 Equity Value
$ 21.08 Per Share

Source: Student Research & Company Data

Appendix B3: Comparative Valuation

Company Name EV/EBITDA

SM Energy 4.7

Apache 4.1
Chesapeake Energy 4.8
Diamondback Energy 12.3
Callon Petroleum 6.4
Surge Energy 4.7
Pioneer Natural Resources 6.7
W&T Offshore 3.9
Concho Resources 9.9
EnCana 4.8
Occidental Petroleum 6.4
Parsley Energy A 6.7
WPX Energy A 5.7

MEDIAN: 6.07

Source: FactSet

Source: Student Research & FactSet

Appendix C: Acreage Positions

Source: Company Data

Source: Company Data