The expression “to beat a dead horse” comes from a clever catch-phrase-ologist in the mid 19th century who identified that beating a dead horse would not make it go faster. The only thing more pointless is identifying “Hey, that horse is dead” and not offering an alternative transport solution.

Today on Twitter, LinkedIn and the internet, SMOG is the name of that horse. As one industry veteran opined “I have worked as an investor for a decade and I’ve never heard of it” and yet, I purport it’s the most important number in an E&P company’s Annual Report.

So now that SMOG has captured your attention, I want to draw your focus to something you may not have realized: it’s widespread and simple use. I have randomly selected 8 large cap E&P companies. For each, I have taken their YE2018 SMOG, net of long term debt and divided that result by outstanding share count. Here are the numbers ($/share).

EOG: 48.98

Pioneer: 56.86 (we have discussed PUD booking practices in another post)

Concho: 50.87 (includes the estimated Q3 writedown impact)

Diamondback: 42.95

Continental: 27.31

Noble: 14.64

Marathon Oil: 10.18

Apache: 14.13

I am not making a judgement call, offering investment advice or even contemplating the meaning these numbers. I am doing simple math based on SEC disclosures.

Companies, no doubt, might be quick to point out that these numbers aren’t “fair market valuations” and, even though I’m doing “the simplest math ever”, the results are misleading and not a representation of the value of the company. To that I say… it’s your number!

Analysts and bankers who build their own models (with whatever assumptions pay the bills) might say “those numbers suck” because… well, they realize THEY aren’t needed if an investor seeking energy exposure could use “Ctrl+F” and search for “Standardized” in every 10-K and have an invest-able (or short-able) thesis in 4 minutes per company. To them I say… why is your guesstimate on inventory, spacing, capital, working interest, NRI and development plan better than the company’s?

What I find most striking when I compiled this data for every energy company I pay attention to is that when using a 10% discount rate, the company’s own 5 year development plan and an SEC price that is higher than the strip today, I am struggling to make the case that most E&P stocks and are currently undervalued (remember these are YE2018 numbers, YE2019 comes out in February).

This simple method is how I’ve built my investment thesis for 2019/2020 publicly traded E&P companies. Debt : EBITDA has to be below 2.5x. SMOG / Debt coverage has to be at least 2 and they can’t trade above 150% of their SMOG value. I’m a simple guy and SMOG is simple to me. It’s predicted 4 of 5 Chapter 11 filings in 2019 and one takeunder in 2020 and so far, it’s served be well in my 3 E&P long positions. It also explains why 3 deals – CPE/CRZO, PE/JAG and PDCE/SRCI – were 0 premium deals: they all traded at about the same Share price / SMOG ratio.

If you really think about it, the SMOG exercise also answers many of the questions I had in early 2019: Why aren’t the super majors driving more consolidation with cash? Why is the equity market closed to new share offerings for seemingly cheap companies? Why did E&P so badly underperform other market sectors? Why aren’t more private equity companies being rolled up by public companies as bolt-ons using shares? The answer becomes pretty obvious. Companies aren’t cheap enough yet.

I’m sure investor relations in all these companies can tell me why their SMOG numbers are low, conservative, fake, understated, poorly calculated and I shouldn’t look at them. But, as an investor without a land deck, a list of non operated wells, well level financials, and drilling plans and inventory, this is the best I’ve got. And now that I’ve pointed it out, I hope more companies focus on it. After all, they don’t report for another 35 or so days so time to get re-running.