Is Now the Time for a Bargain Hunter to Invest in Stone Energy?

As a financial writer who covers a wide swath of names, it is always heartening to revisit a call that has worked out largely as planned. Back in early February 2013, I recommended Stone Energy (NYSE: SGY) at $20, picking it among all the offshore players whose the core producing properties are in the Gulf of Mexico (GOM). That was the time to be greedy, as I noted in my article back then, because Stone Energy was grossly undervalued no matter how you sliced it. 

 

Stone's stock has risen more than 50% since then, coming in line with my forecast and outperforming both the S&P and all the other GOM players, as illustrated below:   

 

 

What? 
In early 2013, Stone was on the operating table and some operational hiccups had a significant impact on the company's production and balance sheet. In GOM, Stone didn't find commercial oil at the deep water Malachite prospect that costed it approximately $22 million. In Appalachia, production dropped below 45 MMcfe per day (net) because it was affected by three third party pipeline failures and an unscheduled gas processing plant outage. As a result, production growth concerns made the investors dump Stone's stock, pushing it below $18 with increased volume. 

So what? 
Stone addressed these challenges effectively and restored its production gradually. Meanwhile, it shelved the growth plans through its conventional shelf GOM assets, by making a strategic shift to the Marcellus shale and GOM deepwater.

 

The pipeline repairs in Appalachia were completed in H1 2013, while several new wells were brought on production in H2 2013, resulting in steady increases in the Marcellus shale production with volumes of over 80 MMcfe per day in December 2013.

 

On the GOM front, Stone made a significant new discovery (Taggart prospect) in the Miocene reservoir. The prolific and deep Miocene reservoir can provide a significant growth platform, and this is the reason why it has been targeted by several E&P companies lately. 

 

For instance, Noble Energy (NBL) made two significant Miocene discoveries last month both in the GOM (Dantzler well) and at the Tamar field offshore Israel (Tamar Southwest well). The Dantzler well encountered over 120 net feet of primarily crude oil pay in two high-quality Miocene reservoirs with estimated gross resources at between 55 and 95 million barrels of oil equivalent. Dantzler represents Noble's third consecutive exploration discovery in the Miocene trend of GOM and complements the company's existing developments at Rio Grande and Gunflint. Thanks to these promising results, Noble anticipates drilling at least two additional Miocene trend prospects in GOM during 2014.

 

The Tamar SW well encountered approximately 355 feet of net natural gas pay within the targeted Miocene intervals, with estimated gross resources of the field to be between 640 billion cubic feet (Bcf) of natural gas and 770 Bcf. Pro-forma this development, Noble's discovered resources in the Eastern Mediterranean total nearly 40 trillion cubic feet of natural gas, underpinning the company's ability to meet the growing market demand in Israel and within that region. 

SandRidge Energy (NYSE: SD) has also been trying to identify new sources of future growth, and could be sitting on a Miocene gusher in the GOM. In the latest earnings release, SandRidge announced that it has licensed 25 blocks of seismic data over Bullwinkle and the adjacent Miocene producing subsalt fields. The purpose was to analyze the Miocene reservoirs that are underneath the Bullwinkle platform.

 

The company has been looking for an industry partner to test this Miocene prospect with estimated gross resources around 200 million barrels of oil. This Miocene-age structure is between 15,000 feet and 25,000 below the surface, and was originally identified by Royal Dutch Shell (RDS.A) but never developed. In 2014, SandRidge plans to spend approximately $115 million on GOM drilling, and needs a gusher more than ever, because it anticipates a production decline of 15%-20% year over year in that region. 

Now what? 
Over the next several quarters, Stone will continue its deepwater efforts by securing the Diamond Ocean Victory rig and the ENSCO 8500 series rig. The Diamond Ocean Victory is scheduled to drill the Amethyst exploration prospect, and ENSCO's rig is anticipated to commence drilling the Cardona and Cardona South development wells in early January 2014. If successful, Cardona and Cardona South production is projected for late 2014 and Amethyst production is projected for 2015.

 

Moreover, Stone accelerates its participation in non-operated deepwater wells. The ExxonMobil-operated Mica Deep prospect will be drilled in early 2014, and the Tomcat deep gas exploration prospect is projected to be at total depth in early 2014 as well.

 

Nevertheless, it is time to take some money off the table now. As shown below, Stone is fully valued compared to its peers that have a balanced commodity mix (~50% oil/liquids) and a significant offshore production: