Sanchez Energy Corp. (NYSE: SN) is a pure-play Eagle Ford exploration and production company with 91,000 net acres in the oil and volatile windows of the Eagle Ford shale play.
SN’s 2011 year-end reserve report prepared by Ryder Scott showed it increased its proved reserves 118% to 6.7 MMBOE, up from 3.1 MMBOE during 2011. The report also identified 9.2 MMBOE of probable reserves and 9.4 MMBOE of possible reserves for total 3P reserves of 25.3 MMBOE. The company’s proved reserves in the Eagle Ford, approximately 97% of which are located in its Palmetto prospect of Gonzalez County, are 84% oil and 86% proved undeveloped. The Palmetto acreage represents about 10% of SN’s 91,000 net acre position in the Eagle Ford (see table below for more detailed information regarding SN’s three Eagle Ford prospects).
On December 15, 2011, SN raised $203 million in equity capital through the sale of ten million shares to the public at $22.00 per share, bringing SN’s total basic shares outstanding to 33.0 million (34.6 million diluted). The company plans to use this capital to expand its footprint in the Eagle Ford where a majority of its leases have full depth rights and are prospective for the Buda Limestone, Austin Chalk and Pearsall shale formations. In addition to the Eagle Ford, SN owns approximately 1,250 net acres in the Haynesville shale in Natchitoches Parish, Louisiana and approximately 82,274 net acres in North Montana prospective for the Heath, Three Forks and Bakken shales.
2012-2013 Drill Plan
SN’s 2011 year-end reserve report prepared by Ryder Scott showed an increase in the company’s proved reserves of 118% to 6.7 MMBOE from 3.1 MMBOE during 2011. Moving forward, expect SN to predominately invest in drilling Eagle Ford wells to grow its proved reserves. The company plans to spend a combined $353 million drilling 46 net wells (16 in 2012, 30 in 2013) of its estimated 763 total net unrisked drilling locations in the oil and liquids windows of the Eagle Ford during 2012 and 2013.
SN is budgeting to spend approximately 47% of its 24-month drilling budget on its Palmetto prospect located in Gonzales County, Texas, where the company owns 9,400 net acres and the remaining 53% of its drilling budget on its Marquis and Maverick prospects where the company owns 54,900 and 26,400 net acres, respectively.
Prospect Breakdown
Source: EIA, Sanchez S-1/A filing dated 11/30/2011
SN recently completed two Palmetto wells in December, Barnhart #5H (50% working interest) and Barnhart #6H (50% working interest), which produced at average 30-day IP rates of 1,318 BOEPD gross on a 14/64-inch restricted choke and 1,235 BOEPD gross on a 14/64-inch restricted choke, respectively. The results of SN’s Barnhart #5H and Barnhart #6H wells in the Eagle Ford compare favorably to GEOI’s three recent Eagle Ford completions in Fayette County (Northeast of Gonzalez County) which produced at average 30-day IP rates of 409 BOEPD. The wells also compare well to EOG’s recent completions in Gonzalez County. EOG’s Kerner Carson Unit (six wells) and King Fehner Unit (four wells) produced at average 30-day IP rates ranging from 757 BOPD to 1,242 BOPD and 761 BOPD to 997 BOPD, respectively.
While SN’s Palmetto acreage is yielding good well results, 60% of the company’s total acreage is in its Marquis prospect, where fewer results have been announced. Sanchez has approximately 457 potential drilling locations and owns a 100% working interest at Marquis, giving it the potential to be a value driver for the company. When we modeled the Marquis prospect at an 83.0% first-year decline and a $7.5 million well cost, each well yielded a 21.3% IRR with a $90 per Bbl and $2.50 per Mcf price deck. However, the data table below shows the prospect is sensitive to these assumptions. If the Marquis wells average a 6.0% shallower decline (see our decline curve for Marquis below) resulting in a 600 MBOE EUR estimate and well costs decrease $1 million per well (we expect well costs to decrease as the play develops), IRRs could increase to 40.4% per well, providing significant value for the company moving forward.
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We also note that SN’s 54,900 net acres on the Marquis acreage spans across the black oil, volatile oil and condensate windows. As a result, we would expect well results to vary across that play. As Sanchez and companies with adjacent acreage, Pioneer Natural Resources (NYSE: PXD), Abraxas Petroleum Corporation (NASDAQ:AXAS) and GeoResources, Inc. (NASDAQ: GEOI) continue to prove up this part of the play we can assign a higher probability of success to the acreage and our decline curve (see below).
Eagle Ford Prospect Decline Curves
Pulling information from Sanchez’s S-1 filing and presentation, we built three estimated decline curves on that d the decline curves below. For comparative purposes, we present the curves and certain key metrics for each area – Palmetto, Maverick and Marquis.
Liquidity
In SN’s S-1 dated 11/30/2011, the company estimated a 24-month capital expenditure budget of $413 million. We expect SN to finance approximately 50% of this budget using proceeds from its December, 2011 IPO through which the company raised $203 million of total net proceeds. The company currently has proved reserves of 6.7 MMBOE and no debt on its balance sheet. As a result of successful drilling and existing proved reserves, the company should have the option to secure a bank line to service any capital needs for the latter portion of its budget.
Valuation
Using a risked cash flow net asset valuation (NAV) methodology, we estimated SN’s equity value to be $27.96 per diluted share at a $90 per Bbl and $2.50 per Mcf price deck. We assigned probabilities of success of 85% at Palmetto, 80% at Marquis and 80% at Maverick. We also looked at the value of SN’s equity using an acreage valuation generated by recent Eagle Ford transactions within SN’s three Eagle Ford prospects (Palmetto, Marquis, Maverick) where we come up with a value of $30.11 per diluted share. Providing equal weighting between the two methods, our target price for SN is $29.28 per diluted share (see table below).
Because of SN’s weighting to oil given its acreage position in the oil and volatile windows of the Eagle Ford, our data table below shows that even if natural gas prices drop 40% to $1.50 per Mcf from the $2.50 per Mcf we used to value SN, our sensitivity analysis below suggests the company will only lose 3% or $0.76 per share. Based on the current commodity price of natural gas, we view SN’s exposure to oil as a positive.
Based on this sensitivity, we estimate that the market is pricing SN shares using a $3.00 per Mcf and $65.00 per Bbl oil price. We note that the twelve month strip price as of January 24, 2012 is $3.01 per Mcf and $100.00 per Bbl.
As gas prices return and the company proves up its acreage through successful drilling, which will reduce dry hole risk, we believe the company’s share price has the potential to appreciate. Using our base case assumption for decline curves and drilling plan, on a best case, with the company achieving a 100% drilling success, we believe SN shares have the potential to be valued at $47.13 per share, a 151% increase to where SN shares traded as of market close January 23, 2012. We also note that with successful drilling results, the company has the natural option to accelerate its drilling plan, bringing production increases nearer term and further adding value for shareholders.
At this time, we did not give any value to the 82,274 net prospective acres SN owns in the Heath, Three Forks and Bakken shales in Montana or the deep rights to the Buda Limestone, Austin Chalk and Pearsall shale formations, both of which provide potential upside for the company’s share price. While we did not assign value to SN’s acreage in the Heath shale in Montana, OAG360 notes that in October, 2009 Endeavor International (NYSE: END) purchased 85,000 net acres in the Heath shale for $4 million or $47.06 per acre.
