Stone Energy: This Stone Can Ignore Gravity

Nathan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Is Stone Energy (NYSE: SGY) a sleeping stock that could fly higher, the way its neighboring McMoRan Exploration flew when it was acquired by Freeport-McMoRan few weeks ago? Although I can't know if Stone is an acquisition target, I know that it is very undervalued currently, and now is the time to get greedy.


Production Growth: Although the production for 2013 is expected to remain relatively flat, with 2012 production at 41,000-44,000 boepd (~54% oil and liquids), the projected production in 2014 and 2015 is expected to grow, exceeding 50,000 boepd as longer-term projects from the Deep Water area are developed. 

Proved Reserves Growth: After the latest independent reserves report in early 2013, the proved reserves climbed up to 129 Mmboe (49% oil and liquids), as compared with 100 Mmboe at year-end 2011, representing a 28% increase in its estimated proved reserves. That was the third consecutive year of reserve growth in 2012. From all sources, Stone replaced approximately 288% of production in 2012. 

Reserve Life Extension: The reserve life for this Louisiana-based producer has grown from 5.2 years in 2009 to approximately 8.5 years currently. 

Funds from Operations (FFO) Stability: Stone has been maintaining stable and positive operating cash flows for four consecutive years. Additionally, most of the operating cash flow for 2013 is protected because Stone has completed its active hedging program for 2013, while the programs for 2014 & 2015 are in progress. 

Earnings Stability: The company has been profitable for ten consecutive quarters and it trades with a low P/E of 7 based on the estimated earnings for 2012. 

Debt/FFO (annualized): The company has a significant safety cushion in place, as the D/CF (annualized) ratio is below 2. The 2013 capital program is expected to be funded by projected cash flow and cash on hand without hurting the debt line. The borrowing base of $400 million under the bank credit facility remains undrawn, with $379 million available after accounting for outstanding letters of credit of $21 million. 

Liquidity: The current ratio (short-term assets/ short-term liabilities) is in safe territory and the company doesn't face any cash shortfall as this ratio currently hovers well above 1. Actually Stone's current cash position is over $200 million after the recent issuance of the $300 million Senior Notes due 2022, and after the completion of the tender offer, redemption and retirement of all the $200 million Senior Subordinated Notes due 2014.  

Pricing: Stone has high margins and strong free cash flow because it receives Louisiana sweet crude pricing, which is very close to Brent pricing

Land and 2P Reserves Diversification: Stone has a balanced portfolio of assets with three core areas. Its operations extend from the liquids-rich Marcellus shale to the conventional shelf and the deep water areas of the Gulf of Mexico (GOM). The corporate 2P reserves are also very diversified. 


The Gulf Coast effects: Due to the fact that Stone produces more than 50% of its oil and natural gas from GOM, it incurs high seasonal maintenance costs for its platforms, which are exposed to hurricanes. For instance, Stone's production was impacted by shut-ins due to Hurricane Isaac in Q3 2012. 

The Operating Hiccups: Stone will lose production in Q1 2013 from the Mary field. This field has been shut-in since December 2012 due to a third party pipeline repair issue impacting 8,350 boepd. The repair will be completed by Feb. 2013. However, the company expects to replace part of the lost production from the La Cantera #3 well that came on stream in Q3 2012. 


Deep Water Exploration Program: Stone's results are dependent on the outcome of various deep water exploration prospects. A part of the capital budget of 2013 is directed on exploration drilling, and Stone expects to participate in 2-4 non-operated exploration wells for 2013 spending $80 million. The company also entered into a joint venture deal with ConocoPhillips on four deep water GOM prospects. Either way, the allure of deep water drilling is indisputable and its impact is hard to dismiss. 

Eagle Ford and Bakken: Part of the capital budget for 2013 is focused on non-operated development drilling in the oil-rich Eagle Ford Shale formation. Additionally, Stone Energy holds 35,000 net acres in Glacier County, Montana targeting the Bakken formation where Newfield Exploration (NYSE: NFX) is the operator, holding 320,000 net acres. Newfield recently sold its GOM assets to focus on its onshore properties (i.e. the Uinta Basin), and it is striving to become oilier, lowering its operating costs. Newfield's production is 51% natural gas, and if its program is successful in Montana Stone's stock will also be positively impacted. Newfield's first well in Montana had an IP=225 boepd. 

Leasehold Position Expansion: The Bureau of Ocean Energy Management (BOEM) awarded Stone and its partners 23 high bid leases from its June 2012 lease sale. 

Significant Discount To Peers: With an estimated exit production of 44,000 boepd in Q4 2012, year-end 2012 proved reserves of 129 MMboe and Enterprise Value (EV) of $2 billion, Stone trades for $45,400/boepd (54% oil & liquids) and $15.5/boe of proved reserves, which is a discount to its peers' valuation. For instance, EPL Oil and Gas (NYSE: EPL) has 22,300 boepd exit production for 2012, along with 77 MMboe proved reserves and an EV of $1.7 billion currently. This gives it $76,200/boepd (71% oil and liquids) and $22.1/boe of proved reserves. EPL was transformed from a gas profile to oil by acquiring four companies within two years, and it forecasts a decent production growth for 2013Additionally, Energy XXI (NASDAQ: EXXI) has production of 47,000 boepd currently, along with 120 MMboe proved reserves and an EV of $3.5 billion. Thus, it trades for $74,470/boepd (68% oil and liquids) and $29.17/boe of proved reserves, operating five of the eleven largest oil fields on the GOM shelf. Energy XXI plans to increase its CapEx to $700 million in 2013, from $591 million in 2012. 


Commodity Volatility: Stone's liquidity is impacted by oil and natural gas prices. If they drop significantly in 2013, the operating cash flow from the unhedged production will decline. 

The bottom line is that Stone is undervalued based on any key metric and the market has turned a blind eye thus far. Although I don't know exactly what Stone is worth, it is worth considerably more than what the current share price suggests.


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