March 28, 2005
Research Associate: Priyanko Basu, ACA , ICWA
Senior Analyst: James Weber, CFA
Editor: Ian Madsen MBA , CFA 800-767-3771 x417
North Wacker Drive Chicago, IL 60606
Swift Energy Company (SFY-NYSE) $27.25
Note: This report contains substantially new material. Subsequent editions will have new or revised material highlighted.
Overview
Swift Energy Company (SFY) is engaged in developing, exploring, acquiring, and operating oil and gas properties, with a focus on onshore and inland waters oil and natural gas reserves in Texas and Louisiana, and onshore oil and natural gas reserves in New Zealand. The Company operated 870 of these wells representing 95% of its proved reserves. Swift Energy has estimated proved reserves of 800 billion cubic feet of natural gas equivalent (Bcfe), of which approximately 47% was crude oil, 41% natural gas and 12% natural gas liquids, and overall 59% is proved developed. The Company's proved reserves are concentrated 40% in Louisiana, 37% in Texas, and 21% in New Zealand. The Company is based in Houston, Texas and employs approximately 240 people. For more information about the Company, visit its website at SFY operates on calendar year basis.
Analysts have identified the following factors for evaluating investment merits of SFY.
Key Positive Arguments / Key Negative Arguments- Lake Washington production trends remain strong; there are several years of production potential at this site.
- SFY has a reserve replacement of 205% over the past three years.
- Natural gas pricing in New Zealand is rising significantly.
- SFY’s cash margin increase was one of the highest in the group.
- SFY completed 52 of 66 wells successfully during 2004.
- SFY’s returns on capital continue to lag its peers appreciably.
- Balance sheet over levered.
- SFY is highly leveraged to one field i.e., Lake Washington.
- Dismal 2004 drill bit performance and high finding costs.
- Production is likely to be curtailed in 1Q05 due to temporary 3rd party gas pipeline shutdown in Lake Washington.
SFY posted 4Q04 EPS ahead of consensus. But its performance is mainly dependent on Lake Washington. SFY’s performance can improve if it can demonstrate meaningful reserve additions and NAV per share growth via deeper, 3-D seismic based drilling at Lake Washington, successful integration of the newly acquired Cote Blanche Island and Bay de Chene fields in Louisiana, and viable development of several plays in New Zealand. (AG Edwards)
Revenues
Total Revenues
Fiscal Year Ends: December $ in millions / 1Q04A / 2Q04A / 3Q04A / 4Q04A / FY2004A / FY2005E / FY2006EDigest High / 65.4 / 71.0 / 74.9 / 98.9 / 310.3 / 356.4 / 335.9
Digest Low / 65.4 / 71.0 / 74.9 / 98.9 / 310.3 / 324.9 / 325.2
Digest Average / 65.4 / 71.0 / 74.9 / 98.9 / 310.3 / 336.1 / 330.5
Digest Average YoY Growth / 48.5% / 8.3% / -1.7%
SFY reported 2004 revenues of $310MM thereby posting YoY growth of 48.5%. It is expected that revenues for 2005 will increase by a more modest 8%.
Proved reserves at year-end 2004 totaled 800 Bcfe, a 3% decrease from 2003 reserves of 820 Bcfe. This slight decrease resulted in part from focusing the company's reduced drilling activity in Lake Washington on close-in proved undeveloped (PUD) locations that helped optimize production in a high-price environment, but which also resulted in smaller additions to proved reserves. The proved developed percentage was 56%. (Raymond James)
Swift reported a 19% YoY increase in total production to 172,369 Mcfepd in 4Q04, from 145,456 Mcfepd in the fourth quarter of 2003. This production growth, in combination with a 57% improvement in commodity price realizations, allowed SFY to report an 86% increase in 4Q04 revenues to $98.9 million versus $53.1 million a year ago. Natural gas prices were 42% higher while Liquids realizations of $43.29 were up 55% versus 4Q03. (Jefferies)
Please refer to Zacks Research Digest spreadsheet for specific revenue estimates.
Margins
FY2003A / FY2004A / FY2005E / FY2006EOperating Margin / 37.3% / 44.7% / 37.1% / 32.1%
Analysts expect SFY to show strong margin expansion over the next 12-24 months on the backs of continued strong oil and liquid price realizations as well as above-average production growth (following production disruptions in Q3’04 largely attributed to Hurricane Ivan). Any further production surprises in NZ, or strong drilling results in Lake Washington should drive margins even higher than current estimates.
SFY posted operating margin of 44.7% for 2004. However 2004 margin was negatively affected by higher DD&A and production taxes. Swift provided an estimated first quarter 2005 domestic lease operating cost range of $0.88-to-$0.93/Mcfe, up 24%-to-31% from $0.71 in the prior quarter. The sharp increase reflects rising compression and chemical costs at its Lake Washington oil field along with the shut-in at the recently acquired Cote Blanche Island property.
Please refer to Zacks Research Digest spreadsheet for more details on margin estimates.
Earnings Per Share
Fiscal Year Ends: December $ / 1Q04A / 2Q04A / 3Q04A / 4Q04A / FY2004A / FY2005E / FY2006EZacks consensus / 0.52 / 0.52 / 0.65 / 0.93 / 2.63
Digest High EPS / 0.52 / 0.52 / 0.65 / 0.93 / 2.62 / 2.90 / 2.50
Digest Low EPS / 0.52 / 0.52 / 0.65 / 0.93 / 2.62 / 1.30 / 1.27
Digest Average / 0.52 / 0.52 / 0.65 / 0.93 / 2.62 / 2.24 / 1.97
Digest Average YoY Growth / 36.8% / 100% / 150% / 188% / 113% / -14.4% / -12.3%
Swift reported 4Q04 EPS of $0.93 per diluted share, handily beating the consensus of $0.89. The positive variance largely came from very robust price realizations, especially in New Zealand, and lower interest expense. 4Q04 EPS was negatively affected by high DD&A expenses driven by low drill bit adds and negative reserve revisions. (Raymond James)
All the analysts reporting have reduced their 2005 & 2006 EPS estimates except one analyst (Lehman)
due to increased operating cost assumptions and revised company guidance.
Please refer to Zacks Research Digest spreadsheet for more extensive EPS figures.
Target Price/Valuation
Target prices for SFY range from $27 to $36 with an average of $30.5. The most common valuation method used by the covering analysts is a 5-8X multiple on FY2005 or FY 2006 EBITDA estimates. This multiple represents the top-end of the peer group, owing to SFY’s above-average growth prospects as well as YTD performance. One analyst has used 5.1x FY2005E DACF as the basis of valuation. (Jefferies)
Rating Distribution
Positive / 30%Neutral / 40%
Negative / 30%
Average Target Price / $30.7
Digest High / $36
Digest Low / $27
Number of Analysts / 10
The primary risk to achieving price target is a depressed oil and gas price environment, which reduces the company’s cash flow generation ability and, consequently, production and reserve growth.
Please refer to Zacks Research Digest Spreadsheet for further details on valuation.
Long-Term Growth
Only one analyst has forecasted a long-term growth rate for the Company. (Lehman) The reason attributable to it is SFY’s potential to either show large scale production growth in New Zealand and Lake Washington, or experience production declines if drilling is not as successful as anticipated. A second growth catalyst for the Company is management’s plan to build out infrastructure at Lake Washington in an effort to hopefully exploit many years of successful drilling despite the natural decline on that site. Any delay or operational issues with this initiative will severely hamper SFY’s ability to grow production and therefore the bottom-line.
During 4Q04, Swift completed the data acquisition phase of its 3-D seismic project in Lake Washington and began to process and correlate this data, which will play a key role in the company's drilling program for 2005 and beyond. Swift Energy recently added a second drilling rig in the Lake Washington area and is continuing its focus on long-term planning for production growth and the enhancement of facilities in this field. The company is in the planning and design stages to expand capacity at two of its production platforms, the CM3 and the 6700 platforms.
SFY has acquired additional assets in South Louisiana and if the company can execute well on these assets, its domestic growth visibility could be extended for another few years, but SFY is only in the early stages of seismic appraisal and drilling will not commence until later in 2005 or 2006. (JP Morgan)
However with the current mix of assets, analysts believe that SFY’s growth outlook lacks much-needed diversity and the stable underpinning of a longer lived, onshore legacy asset that offers multiple years of drilling opportunity. (JP Morgan)
Other Discussion/Capital Structure/Cash Flow/Solvency/Governance
Capital spending totaled $190 million in 2004 and is projected to range from $200 million to $220 million, net of dispositions, in 2005. About 80% of the budget is targeted for domestic activities (primarily southern Louisiana), with the other 20% allocated for New Zealand. About $15 million to $20 million will be focused on activity at the newly acquired properties, Bay de Chene and Cote Blanche Island. (Raymond James) Swift likely will fully spend its cash flow this year, despite historically high crude oil and natural gas prices, due to a relatively high unit cost structure. (JP Morgan)
SFY’s net debt-to-capital has dropped to 45% at the end of 2004.
Individual Analyst Opinions
POSITIVE RATINGS
Raymond James – Outperform ($36): 02/17/2005 - Despite the higher cost outlook, the analysts remain bullish on Swift for its ability to achieve robust production growth organically. Thus, they have reiterated their Outperformrating and a $36 target price.
NEUTRAL RATINGS
A.G. Edwards – Hold: 02/22/2005 - The analysts have maintained their Hold rating in light of the company’s rising costs, disappointing reserves, and above average undeveloped reserve percentage.
Friedman Billings – Market Perform ($30): 02/24/2005 -The analysts have recommended the investors to remain patient, as they do not expect catalysts, in the form of accelerated production growth or meaningful exploratory drilling results, to occur until mid to late 2H05. Therefore, they have reiterated their Market Perform rating and 12-month price target of $30.
NEGATIVE RATINGS
CSFB – Underperform ($27): 02/28/2005 - As there are several peers with better visibility and lower volatility in reserve additions that trade at lower multiples, the analysts have maintained their Underweight recommendation on SFY. However, they have raised their 12-month target on Swift to $27 from $22, assuming the shares trade at 5.0 times their ’06 EBIDA estimate.
J.P. Morgan – Underweight: 03/18/2005 -The analysts continue to emphasize the production concentration risk implicit in SFY's Lake-Washington-heavy asset base. Given high PUD percentage (44%) and lower-margin producing assets in New Zealand, cost structure and asset intensity that ranks within the lower quartile of the peer group, they have maintained their Underweight rating on the stock.
Lehman – Underweight ($25): 02/22/2005 -The analysts have maintained their Underweight rating on the stock with a target price of $25 mainly influenced by the fact that SFY’s production outlook is heavily dependent on the Lake Washington Field.
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