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SM Energy Company’s third-quarter 2011 profit recorded a substantial jump on operating income that buoyed up on greater production as well as the recognition of a gain on divestiture operation related to the previously announced sale of its Eagle Ford shale properties.

Third quarter adjusted earnings of 63 cents per share more than doubled the year-ago earnings of 31 cents. The results however failed to meet the Zacks Consensus Estimate of 69 cents.

Total revenue of $530.6 million leaped 133.9% from $226.9 million in the prior-year quarter. Oil, gas and natural gas liquid (NGL) production revenues contributed $325.2 million (up almost 65% year over year) to the total revenue.

Operational Performance

The company’s third-quarter production came in at 462.1 million cubic feet equivalent per day (MMcfe/d), up a considerable 55% year over year, and within management’s target range of 453–481 MMcfe/d.

SM Energy produced 281.2 million cubic feet per day (MMcf/d) of natural gas in the quarter, reflecting a 44% year-over-year growth. Oil production also climbed 25% year over year to 21.5 thousand barrels per day (MBbls/d). Natural gas liquid contributed 8.6 MBbls/d to the total volume.

Including the effect of hedging, average equivalent price per thousand cubic feet (Mcf) was $7.40 compared with $7.51 in the year-ago period. Average realized prices (inclusive of hedging activities) were $4.89 per Mcf of natural gas and $75.02 per barrel of oil, down 16% but up 17%, respectively, from the comparable quarter last year.

On the cost front, unit lease operating expense (LOE) decreased 11% year over year to 94 cents per Mcfe in the quarter. Transportation expenses increased substantially to 56 cents per Mcfe (from 18 cents in the year-ago period); general and administrative expenses were 70 cents per Mcfe (down 27%); while depletion, depreciation and amortization (DD&A) expenses decreased 5% to $2.89 per Mcfe from the year-earlier level of $3.05 per Mcfe.

Liquidity

Operating cash flow improved to $184.6 million during the quarter from $130.1 million in the year-ago quarter. At the end of the quarter, the company had cash balance of $29.9 million and long-term debt of $632.6 million, with a debt-to-capitalization ratio of 28.5%.

Guidance

The company’s production forecast for the fourth quarter of 2011 is in the range of 44 Bcfe to 47 Bcfe, of which oil, natural gas and NGL are estimated to comprise 30%, 58% and 12%, respectively, of the total production. The company’s LOE per Mcfe will likely be in the range of 90 cents to 96 cents for the fourth quarter. The company also expects DD&A to remain in the $2.90–$3.10 range for the fourth quarter.  

For 2012, the company provided preliminary production forecast in the range of 225–232 Bcfe.

The company’s preliminary 2012 capital spending is expected to remain within $1,400 million and $1,500 million.

Outlook

Denver, Colorado-based oil and gas company, SM Energy remains proactive in its attempt to hold a significant position in emerging shale plays and focus more on resource, with an inventory of repeatable drilling prospects and a high rate of return. We believe that the company’s emerging core portfolio is a positive catalyst for visible organic growth over the next several years.

During the quarter, SM Energy closed its previously announced sale of approximately 15,400 net operated acres in LaSalle and Dimmit Counties, Texas for cash proceeds of $226.9 million, before certain adjustments. The arrangements are a part of SM Energy’s objective to offload approximately 20% to 30% of its 250,000 net acre Eagle Ford Shale position. We believe these divestitures will help the company to streamline its portfolio while holding a significant position in emerging shale plays.

However, our long-term Outperform recommendation stems from SM Energy’s natural gas-weighted reserves. The company derives a significant portion of its operating revenues from natural gas.

SM Energy’s competitor, Range Resources Corporation also reported stellar third-quarter 2011 earnings piggybacking on higher production level, realized prices and lower unit costs.

We currently maintain a long-term Outperform recommendation on SM Energy. However, the company holds a Zacks #3 Rank, which is equivalent to a short-term Hold rating.

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