Why I Sold Silver Bow Resources (NYSE:SBOW)

onur dongle

Six months ago I rated SilverBow Resources (NYSE:SBOW) a buy and in 2021 I rated it a rare strong buy. I am now ranking it as a sell and have sold my shares.

Distracted by a takeover conflict with net-zero activist investor Kimmeridge, SilverBow Resources has no plans to return capital to investors. The company does not pay a dividend, nor does it have a share repurchase program.

Kimmeridge Energy

Kimmeridge Energy is a declared activist investor, one of whose primary goals appears to be to nudge companies toward net-zero (less carbon intensive, eg at a minimum less oil) production. For example, when invested in Chesapeake (CHK), Kimmeridge advised Chesapeake to get out of oil production, and Chesapeake did so.

Thus, it is unlikely that Kimmeridge would support, for example, SilverBow’s current capital budget strategy directed half at oil and half at natural gas.

In September, Kimmeridge disclosed it had spent more than $100 million to acquire 14.7% of SilverBow’s shares. The same month, SilverBow announced its board had adopted a limited-duration stockholder rights plan that allows it to double its shares if Kimmeridge acquires 15% of its outstanding stock (thus diluting Kimmeridge to 7.5%).

Also notably, Kimmeridge Energy has bought Laredo Energy–NOT to be confused with Laredo Petroleum (LPI). Laredo energy is a nearby Eagle Ford dry gas producer. A possibility is that Kimmeridge wants to combine SilverBow with Laredo Energy.

Kimmeridge’s is an anti-growth strategy for (or really against) oil companies. Investors with a different long-term view of the need and prospects for oil (and coal) development may wish to avoid co-investing with Kimmeridge or may wish to simply skip this particular corporate governance battle.

SilverBow’s Third Quarter 2022 Results

In the third quarter of 2022, SilverBow Resources reported net income of $143 million, including a net unrealized gain on derivatives of $89 million. (Nine-month net income was only slightly larger at $167 million.) Net production was 299 million cubic feet of natural gas equivalent/day (MMCFe/D), of which 70% was natural gas and the remaining 30% oil and natural gas liquids.

For the first nine months of 2022, net cash from operations was $212 million. Additions to property and equipment and acquisitions of oil and gas properties totaled a net use of cash (in investing) of -$454 million.

While the company’s average realized price per MCFe for all production in 3Q22 was $8.81/MCFe, its average price after derivatives was $5.75/MCFe.

More specifically, the average realized price of natural gas (alone) was $7.81/MCF but its average price after derivatives was $4.34/MCF.

Indeed, in its investor presentation, SilverBow explains its Eagle Ford production gets better (higher) US Gulf Coast gas pricing, an advantage for all Eagle Ford gas producers vis-a-vis west Texas Permian basin gas producers (like APA Corp.) ( APA).

hedges

Typically, smaller companies have commodity hedges to allow predictability of cash flows.

At October 28, 2022 for the rest of 2022 SilverBow has hedged 167 MMCF/D of natural gas, 8420 BPD of oil, and 3750 BPD of natural gas liquids. This represents 230 MMCFe/D, or about 77% of production.

For 2023, it has hedged 179 MMCF/D of gas, 7300 BPD of oil, and 3750 BPD of NGLs.

Sundance, SandPoint, and Others

Earlier this year, SilverBow bought additional Eagle Ford producing assets (Sundance and SandPoint) and integrated them with its own production. These are illustrated in the map below and included in the 3Q22 results above.

In August, it bought $35 million in EF natural gas assets from Arkoma.

In October, the company made another $87 million bolt-on acquisition for assets in the Karnes Trough of the Eagle Ford.

Fit of Sundance and Sandpoint Assets with SilverBow

sbow.com

US Natural Gas Production and Prices

On November 10, 2022, the NYMEX natural gas future prices for December 2022 delivery at Henry Hub, Louisiana was $6.24/MMBTU.

chart
Data by YCharts

Be aware that spot natural gas prices trend up and sometimes spike during winter, depending on the weather, and then fall in the spring. Per the EIA’s Natural Gas Week, “Working natural gas in storage in the Lower 48 states as of October 31, 2022, totaled 3.531 billion cubic feet (BCF), according to month-ending estimates. This total is the second-lowest end- of-refill-season inventory level since 2008.”

Lower 48 working natural gas inventories in underground storage at the end of refill season (April 1-October 31)

Energy Information Administration

Additionally, due to a near-complete cutoff of Russian natural gas pipeline exports to Europe and the UK accounting for 40% of these countries’ consumption, substituted LNG import prices soared. Natural gas prices have since settled lower because European and UK gas storage has been filled but are still several multiples of the year-ago European price. For example, the Title Transfer Facility (TTF) (Dutch) LNG price on November 10, 2022, for December 2022 delivery was $33.38/MMBTU.

US dry gas production was 99.9 BCF/D for the week ending November 9, 2022, so small SilverBow’s 3Q22 gas production (excluding oil and natural gas liquids) of 209 MMCF/D represents only 0.21% of the total.

The chart below shows growth in US shale gas production and the mix between basins. The lighter blue stripe represents the Eagle Ford formation in Texas, SilverBow’s primary area of ​​production.

US dry shale production by basin

Energy Information Administration

Reserves

SilverBow’s total proved reserves on December 31, 2021, were 1.42 trillion cubic feet of gas equivalent (TCFe), of which developed reserves were 658 billion cubic feet of gas equivalent (BCFe).

Most (81.6%) is natural gas; only 18.4% is natural gas liquids and oil.

The SEC PV-10 value of future net cash flows of proved reserves is $1.82 billion, up from $526 million at year-end 2020. The location-adjusted average 2021 prices used in the calculation were:

$3.75/MCF for natural gas (compared to $2.13/MCF last year);

$63.98/barrel for oil (compared to $37.83/barrel last year);

$25.29/barrel for natural gas liquids (compared to $11.62/barrel last year.

The map below shows the hydrocarbon windows in the south Texas Eagle Ford.

Eagle Ford Basin Producing Areas

sbow.com

The PV-10 calculation above does not include the Sundance and Sandpoint acquisitions. If their PV-10s are included (and note-these are only for proved developed, not proved undeveloped, so they are conservative), the total would be $2.19 billion.

Competitors

SilverBow’s headquarters is in Houston, Texas. Some of its larger Eagle Ford competitors include BP (BP), Chesapeake, ConocoPhillips (COP), Devon Energy (DVN)-which just bought private company Validus–EOG Resources (EOG), Marathon Oil (MRO), and Exxon Mobil ( XOM). It also partners with/offsets to ConocoPhillips and Ranger Oil (ROCC).

South Texas Eagle Ford production competes with all US gas basins-especially the enormous Appalachian reserves, those in the Louisiana Haynesville, and associated gas from the west Texas Permian.

governance

At November 1, 2022, Institutional Shareholder Services ranked SilverBow’s overall governance a 6, with sub-scores of audit (1), board (8), shareholder rights (9), and compensation (4).

In this ranking a 1 indicates lower governance risk and a 10 indicates higher governance risk.

Approximately 8.0% of the floated stock is shorted and insiders own 2.2% of the stock.

Beta is 2.4. This is considerably more volatile than the overall market but matches the company’s status as a gas producer in a turbulent energy pricing environment, and the current situation: as described above, Kimmeridge Energy has launched a takeover bid for SilverBow and SilverBow has responded with a poison pill.

As of September 29, 2022, Strategic Value Partners, LLC owned 18.4% of the company’s stock. This is down from about a quarter of the company’s equity earlier. Recall that SilverBow Resources was the company formed five years ago from Swift Energy after Swift’s bankruptcy. Per Crunchbase, Strategic Value Partners “is a global alternative investment firm focused on distressed and deep value opportunities.”

at June 29, 2022the next largest holders were Kimmeridge Energy at 7.9% (but as of September at least 14.7% apparently), Angelo, Gordon at 6.9%, Apollo Management at 5.5%, Ares Management at 4.9%, Fidelity/FMR at 4.5%, and Adage Capital Partners–which manages investments for endowments and foundations–at 3.7%.

Angelo, Gordon and Ares Management are both alternative investment managers.

SilverBow’s Financial and Stock Highlights

SilverBow’s market capitalization is $770 million at the November 10th, 2022, stock closing price of $34.52 per share.

Its 52-week trading range is $19.00-$49.91/share, so the current price is 69% of the high and 50% of the one-year target price of $68.75.

Trailing twelve-month earnings per share (EPS) is $15.49 for a very bargain current price-earnings ratio of 2.2. The averages of analysts’ expected EPS for 2022 and 2023 are $15.98 and $16.47, giving a similar very bargain forward price-earnings ratio range of 2.2-2.1.

SilverBow’s trailing twelve months’ operating cash flow is $294 million and levered free cash flow is -$215 million.

The company’s trailing twelve-month returns on assets and equity are excellent at 18.0% and 79.7% respectively.

As of September 30, 2022, the company has $973 million in liabilities including $626 million of long-term debt and $139 million in fair-value commodity derivatives ($109 million of which is a short-term liability).

SilverBow has $1.59 billion of assets, for a liability-to-asset ratio of 61%. The ratio of long-term debt to EBITDA is 1.4.

chart
Data by YCharts

Book value per share of $27.66 is below market value, indicating positive investor sentiment.

With an enterprise value of $1.47 billion, the company’s EV/EBITDA ratio is a very investor-attractive 3.3. Because natural gas production tends to be lower valued than oil production, SilverBow’s market capitalization per flowing BOE is only $15,400, about a fourth that of, for example, Equinor (EQNR) or 18% that of ConocoPhillips.

Summary comparison: market capitalization is $770 millionenterprise value is $1.47 billion, and PV-10 of reserves (including the Sundance and Sandpoint acquisitions) is $2.2 billion.

SilverBow Resources does not pay a dividend and has no share repurchase program.

The mean analyst rating from four analysts is a 2.0, or “buy.”

Positive and Negative Risks

The biggest driver is likely to be the outcome of the Kimmeridge takeover battle, including actions SilverBow takes to counter it.

More general factors are inflation in all costs and the Federal Reserve’s future interest rate raise trajectory.

Potential investors should consider their US natural gas price expectations, particularly in the south Texas Eagle Ford basin, as the factor most likely to affect SilverBow. As with all commodity-driven companies, it is subject to price fluctuations which are only partially offset by hedging.

The big growth in US Gulf Coast LNG facilities and export is a positive risk factor for SilverBow and other gas producers in the Haynesville and Eagle Ford basins particularly.

The company also has positive uplift from its oil and natural gas liquids production.

Recommendations for SilverBow Resources

I recommend selling SilverBow shares and have done so myself.

The goals of long-term, value-seeking, and dividend/capital return-seeking investors may not be met by SilverBow Resources given the differing goals of its largest equity holders and managers. The current dynamics between management, 18%-owner Strategic Value Partners, net-zero activist Kimmeridge Energy, and others do not favor long-term or individual investors.

Because the company is hedged, it may not realize all the upside from higher gas prices. Its high liability-to-asset ratio of 61% could result in exposure as debt costs rise.

Day traders and speculators may find the stock of interest.

SilverBow Resources logo

sbow.com

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