Book 50% Gains With This Energy Growth Stock

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

Shares of SM Energy (NYSE: SM) are likely to increase by 50% over the next year as the company continues to execute on its robust growth strategy.
 
The company is a rapidly growing energy producer which operates strictly onshore in the continental US. Over the past several quarters, its earnings have been rapidly improving as SM Energy dramatically increased production.
 
Over the next few quarters, analysts and investors will be forced to incorporate accelerating growth expectations for this company. As a result, demand for the stock will increase, and I expect the stock price to trade up to a target of $94.50 per share.
 
Picking up shares of this stock today will give investors a great shot at generating profits of 50%.
 
Record production boosts expectations
 
In the first quarter of 2013, SM Energy produced a record 10.3 million barrels of oil equivalent (MMBOE), which was at the top end of management's guidance.  
 
As part of the company's Q1 report, management issued guidance for further growth in the second quarter and throughout the year. For the second quarter, management expects to produce 10.5 to 11.0 MMBOE, and for the full year SM Energy should produce 42.8 to 44.5 MMBOE.
 
With natural-gas prices still relatively low, SM Energy will focus on increasing production of its liquids portfolio. This makes sense given the current energy pricing environment, and also saves the company's natural-gas assets for future periods when natural-gas pricing improves.
 
As I mentioned in my Anadarko Petroleum article, natural-gas pricing is expected to increase as the Department of Energy shifts its stance on liquid natural gas (LNG) export facilities. Over the next few years, the new export policy should boost US natural-gas prices, which in turn will benefit producers like SM Energy.
 
As a result of the strong first-quarter performance, analysts are increasing their estimates for SM Energy, as you can see in the table below.
 
 
A dramatic increase in analyst expectations can be very positive for a company's stock-price performance. This dynamic indicates that investors are behind the curve in terms of assessing a company's growth prospects and as new data is evaluated, demand for the stock can increase significantly.
 
As SM Energy increases production, analysts are now expecting the company to earn $3.10 in 2013 followed by a 22% increase in earnings to $3.78 in 2014. It is reasonable to expect the estimates to continue to increase as new information is analyzed, but we'll use the 2014 estimate of $3.78 to be conservative. 
 
With the company growing earnings at a 22% annual rate, investors should be willing to pay at least 20 times earnings for this growth opportunity. (Investors are currently paying more than 20 times 2013 earnings for the stock, so this valuation seems more than reasonable.)
 
This leads to an expected stock price of $94.50 (20 times earnings of $3.78), which should be reached sometime in the next 12 months. This represents a gain of 50% from the current stock price, and may wind up being a very conservative expectation.
 
Ahead of the competition 
 
Not all US energy producers have the same type of growth profile that SM Energy enjoys.
 
For example, Southwestern Energy (NYSE: SWN) is expected to grow earnings by less than 10% between 2013 and 2014, and yet the stock is still trading at a multiple of roughly 20 times forward earnings. 
 
Southwestern Energy is active in purchasing new land for exploration and development. In late April, the company inked a deal with Chesapeake Energy to buy 162,000 acres for a price of $93 million.
 
With a significant debt load of $1.7 billion, and a debt-to-equity ratio listed at 55.3, Southwestern Energy is taking on near-term financial risk. If investments in new acreage pay off quickly, investors will benefit. But the big question is whether Southwestern Energy can develop this new acreage quickly enough - especially since natural-gas prices are still at a relatively low price point.
 
Unless Southwestern Energy is able to surprise investors with increased production or wider-than-expected profit margins, investors are likely to endure losses, or at best, find themselves sitting on a dormant asset while other energy stocks advance.
 
Similarly, Apache (NYSE: APA) is expected to grow earnings by roughly 11% between 2013 and 2014. Apache's stock is priced much more reasonably at about 10 times expected earnings.
 
This reduces the amount of risk that Apache shareholders are subjected to, but with much less growth over the next 18 months there is an opportunity cost in play.
 
Even though Apache has been able to successfully increase production levels over the past few quarters, the company has been unable to convert that additional production into actual earnings growth. In fact, over the last year, the company has missed analyst expectations every single quarter. 
 
Apache's management team has begun working on shifting the company's focus to "drive production growth, and create shareholder value." This year, the company will divest $4 billion in assets and use the proceeds to reduce debt and also repurchase shares.
 
The new arrangements will help create a more stable financial base for the company, but will not help in boosting the company's overall growth. As a long-term investor, I would rather own a company that is actively investing in growth, rather than divesting assets for financial stability.
 
Invest before the next earnings announcement 
 
I would recommend picking up shares of SM Energy well in advance of the next quarterly earnings announcement, which is scheduled for July 29. 
 
Since analysts have been active in boosting their expectations following the last earnings announcement, it is likely that institutional investors will begin building positions ahead of the next announcement. This additional demand is likely to drive the stock significantly higher over the next few months.
 
Take advantage of SM Energy's tremendous value today and consider adding to your position incrementally as the story plays out. I expect that the news flow will continue to be strong for this impressive growth company and I look forward to seeing just how conservative the 50% target turns out to be.
 

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Zachary Scheidt has no position in any stocks mentioned. The Motley Fool owns shares of Apache. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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