BUY (SN, $6.66)
Eagle Ford Based Producer Offers Additional Upside In Our View: Initiating BUY With $9 Price Target
June 27, 2016
Glenn Williams Jr.
We are initiating coverage on Sanchez Energy with a BUY rating and $9 price target. Given Sanchez’s current price levels, and our expectations for both production and cash flows, we contend that company is undervalued at current levels. We value SN’s equity on the basis of daily production along with projected EBITDA, and proved reserves. Additionally, we include a set of valuation multiples derived from a selection of industry peers. In doing so, we arrive at a value per share of $9, implying 35% additional upside, given today’s prices.
We expect that balance sheet stabilization and maintenance of liquidity will be the primary focus in 2016. With $362 million in cash on the balance sheet, along with an undrawn $300 million revolver, we expect Sanchez to focus on the protection of both, moving forward (along with the reduction of current debt levels). We note that Sanchez’s first debt obligations do not come due until 2021. Still, the company’s net debt load relative to capital (114%) could prove burdensome moving forward. Additionally, investors should expect a moderation in 2016 production levels, relative to 2015. Specifically, we project 50.7 thousand barrels of oil equivalent (Mboe) per day in 2016, from 52.6 Mboe per day the year prior. However, we expect Sanchez to refrain from the issuance of additional debt or equity this year. Instead, we anticipate that Sanchez will leverage its relationship with Sanchez Production Partners (SPP), as a source of funds. Through its escalating working interest (EWI) program, Sanchez divests a portion of its working interest to SPP after 2 years of production, using the proceeds for investment in new drilling. To date, the program has generated $430 million in additional capital for the firm, without the addition of debt or dilution of shareholders.
We base our price target on a blended average of Sanchez’s daily production, proved reserves, and projected EBITDA figures. In doing so, we arrive at a price target of $9 per share (Exhibit 10). Additionally, our model adds $6.91 for a working capital surplus, while deducting $23.14 per share for net debt. Thus, given the 35% implied upside to current prices, we initiate coverage on Sanchez with a BUY rating.
Source: Capital IQ; National Securities Corporation
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