On a day when markets tanked, natural gas and oil exploration and production company SM Energy (NYSE:SM) bucked the trend, rising 10%. And a prominent analyst boosted its price target. Should you buy?
SM Energy generated better-than-expected second-quarter results. From its operations in five areas — “the Mid-Continent, Rocky Mountains, ArkLaTex, Permian Basin, and Gulf Coast regions” — SM produced more and got higher prices. As a result, SM reported adjusted EPS of 91 cents, 69% higher than the Zacks Consensus Estimate of 54 cents.
Total revenue of $377.9 million was 78.5% higher than the year before and 26% above the Zacks Consensus Estimate of $301 million. Oil, gas and natural gas liquid (NGL) production revenues contributed $333.9 million — up nearly 90% from the year before — to its total revenue
And if that’s not enough, analyst Stifel Nicolaus raised its price target on SM to $100 (it currently trades at $82.83).
Here are two reasons to consider buying SM stock:
- Great earnings reports. SM has been able to beat analysts’ expectations consistently, doing so in four of its past five earnings reports. In its report Tuesday, it beat analysts’ expectations as noted above.
- It’s cheap. SM’s price/earnings-to-growth ratio of 0.48 (where a PEG of 1.0 is considered fairly priced) means its stock price is inexpensive. It currently has a P/E of 34.7 and is expected to grow 72.6% to $3.48 in 2012.
Here are two reasons to pause on SM:
- It is under-earning its cost of capital. SM is earning less than its cost of capital — and it’s getting worse. How so? It produced positive EVA momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first six months of 2011, SM’s EVA momentum was -9%, based on first six months’ 2010 annualized revenue of $1.1 billion, and EVA that fell from $101 million annualizing the first six months of 2010 to -$4 million annualizing the first six months of 2011, using a 9% weighted average cost of capital.
- Moderate growth, flat profits and shakier balance sheet. SM has been growing slowly. Its $1.1 billion in revenues has increased at an average rate of 8.5% over the past five years while its net income of $197 million is barely up, yielding an 18% net profit margin. Its debt has grown quickly, but its cash has grown faster. SM’s debt climbed at a 23.5% annual rate, from $271 million (2006) to $630 million (2010), while its cash has grown at a 78.3% annual rate, from $10 million (2006) to $101 million (2010).
SM Energy is on a growth roll now. But if there is a slowdown in the economy, it might get lower prices for its booming output. That would expose the weaknesses in its balance sheet.
If you think SM is going to continue to enjoy rapid growth, its stock still is cheap. If you’re worried it might suffer from a double-dip recession in the U.S., hold off.
Peter Cohan has no financial interest in the securities mentioned.
