SM Energy and Carrizo Could Strike a JV

SM Energy [stock_market_widget type="inline" template="generic" color="default" assets="SM" markup="(NYSE: {symbol} {currency_symbol}{price} ({change_pct}))" api="yf"] has been in cost-cutting mode as it tries to negate the impact of weak oil prices on its finances, which is why the news of the company tying up with another oil and gas player doesn’t come across as a surprise. Bloomberg reports that SM Energy could be in talks with Carrizo Oil and Gas [stock_market_widget type="inline" template="generic" color="default" assets="CRZO" markup="(NASDAQ: {symbol} {currency_symbol}{price} ({change_pct}))" api="yf"] for a tie-up as the two companies look to derive cost synergies.

What’s Happening?

According to people familiar with the matter who spoke to Bloomberg, the companies have held early-stage discussions. Though there’s no guarantee of a deal, it won’t be surprising to see Carrizo and SM Energy striking up a joint venture to improve the efficiency of their operations in New Mexico and the Permian Basin of Texas.

That’s because the volatile oil pricing scenario could pressure the performance of both companies. Carrizo and SM Energy have managed to defy the weak oil pricing environment so far thanks to an increase in their production, lower costs, and better pricing than the others in the industry.

For instance, Carrizo’s revenue was up 11% in the fourth quarter of 2018 on the back of a 9% production increase. The company had also enjoyed higher oil pricing during the quarter and also for the full year, but that might not be the case in 2019.

Why This Could be a Smart Move

Carrizo predicts oil production growth of 10% in 2019.

Carrizo predicts oil production growth of 10% in 2019 despite cutting its capital expense from $969 million last year to a range of $525 million-$575 million this year. So the company is already taking steps to protect its funds flow profile against any weakness in the oil price by giving its capex such a large cut.

Similarly, SM Energy will bring its capital expenses down from $1.3 billion last year to a range of $1 billion-$1.07 billion in 2019. That’s despite the fact that SM’s production was up 9% during the fourth quarter of 2018 and the company also managed to improve its operating margin by 19% on account of lower costs.

SM plans to spend its money wisely this year, allocating 90% of its budget toward drilling and completion. Also, the company has a history of lowering its well completion costs with the help of joint ventures. SM plans to drill 12 gross wells and complete an identical number this year at no incremental cost to the company thanks to its partnership with another company.

In such a scenario, it could be ideal for the company to strike another tie-up with Carrizo to drive more efficiency. SM plans to increase its production to a range of 45-48 MMBoe in 2019 from 43.9 MMBoe last year, an increase of almost 6% at the mid-point. It would need higher oil prices to take advantage of the increase in the production, but analysts don’t think the same as a drop in its top line is expected in 2019.

Lower revenue will also hurt the company’s bottom line, especially if prices decline. In such a scenario, it would be ideal for SM Energy and Carrizo to strike a joint venture and realize more value from their operations.

Harsh Singh Chauhan has a wealth of experience evaluating publicly-traded companies across several verticals, including technology, oil and gas, retail, and consumer goods. His financial writing has been published across platforms such as The Motley Fool, TheStreet, and Seeking Alpha. Harsh's philosophy is to find great businesses for the long run based on company fundamentals and industry prospects. Address: 682 Indian Road, Toronto, Ontario, M6P 2C9. Phone: 416-721-8257.


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