Occidental Petroleum (OXY): E&P portfolio reloaded, relative valuation inexpensive, reinstating view with OP/A rating following a period of Not Rated - Goldman Sachs - January 30, 2006
After a period of being Not Rated, we are reinstating our view on Occidental Petroleum (OXY) with an Outperform rating relative to an Attractive coverage view. With the Vintage Petroleum acquisition just closed, key new growth projects added in Libya and Oman, and continued exploitation potential in legacy Permian Basin (Texas) and California oil fields, we believe Oxy is on-track to generate mid-single digit underlying volume growth at top-quartile profitability. While we classify Oxy as a large-cap E&P/domestic oil, we think Oxy can also increasingly be thought of as a suitable alternative to the super-cap integrated oils. Although the shares have rebounded from the low $70s to just above our $90 mid-cycle value, we still think the stock is very inexpensive and see 22% upside to a $110 "traditional" peak value and potentially as much as 60% upside to a $143 "super-spike"-adjusted peak value.
For additional details on our views on Occidental Petroleum see our November 1, 2005 research note "E&P portfolio positioned to resume multi- year growth at industry-leading ROCE"
Message 21844140
, our October 14, 2005 research note "Oxy to acquire Vintage Petroleum" Message 21794600 , and our May 26, 2005 report, "Upgraded to OP given reloading of E&P portfolio." Message 21360559
KEY REASONS TO REINSTATE OCCIDENTAL PETROLEUM WITH AN OP/A RATING
(1) E&P portfolio re-loaded. Following a transition year in 2005, Oxy has re-loaded its E&P portfolio and we think is on-track to grow E&P production volumes at a competitive mid-single digit rate with top quartile profitability--an unmatched combination of growth AND returns among $35+ billion market cap. US-based oil companies.
(2) Favorable commodity leverage. Oxy has superior leverage to our continued bullish commodity macro outlook in particular relative to other $35+ bn market cap. oil companies. The value of Oxy's long-lived E&P asset base would especially benefit from our view that investors are likely to further ratchet-up expectations for long-dated commodity prices in 2006.
(3) Exceptionally strong balance sheet. Oxy's balance sheet is forecast to return to near net debt free status later this year. We believe this points to the potential for increased cash being returned to shareholders and plenty of flexibility to secure additional E&P projects in Oxy's core areas of the Middle East, Latin America, and the United States.
(4) Inexpensive valuation. Oxy's valuation appears inexpensive at 4.4X 2007E EV/DACF, 8% below the peer group average of 4.8X 2007E for super-/large-cap E&Ps and integrated oils excluding the oil sands-leveraged companies. Oxy's 2007E free cash yield is even more striking at 12.5%, which compares favorably with the under 9% free cash yield of its peers. Given Oxy's favorable mix of long-lived, visible production growth and top quartile profitability, we think it should be trading at a premium to the peer group, not at a discount or even parity.
(5) Attractive risk/reward. Oxy is currently trading just above our $90 mid-cycle value and has 22% upside to a $110 "traditional" peak value that is consistent with a $45/bbl long-term WTI oil price assumption. We see 60% upside potential to a $143 "super-spike"-adjusted peak value that would be consistent with using a $60+ long-term WTI oil price similar to the current long-dated forward curve for oil. By way of comparison, Oxy's peer group is trading 15% above mid-cycle, has 14% potential upside to traditional peak, and around 50% potential upside to "super-spike"-adjusted peak values.
KEY CATALYSTS/EVENTS FOR SHARES
(1) January 30 - Closing of Vintage acquisition.
(2) February 7 - 4Q 2005 EPS results. Historically earnings results have not been a major catalyst for Oxy shares; we highlight this only as an upcoming event. Our 4Q 2005 EPS estimate of $2.78 is essentially in-line with the $2.75 First Call consensus forecast. Our 2006E EPS estimate of $13.75 is 29% above the $10.70 First Call consensus projection, with the bulk of the variance likely driven by our $68/bbl 2006E WTI oil forecast compared to a consensus expectation that still appears to be about $10/bbl lower.
(3) February 23 - New York analyst meeting. This will be Oxy's first analyst meeting in five years. The last analyst meeting highlighted Oxy's plans for the 2000-2005 period, which Oxy overwhelmingly achieved. We expect positive relative stock price performance heading into the meeting (some of which has already occurred). The meeting itself we think will be a positive event.
(4) Over the course of 2006 we expect investors to increase their expectations for long-dated WTI oil prices from $40-$45/bbl to something approaching $60/bbl. Oxy with its long-lived, visible production growth would be a major beneficiary.
(5) Over the course of 2006 we expect Oxy to return an increasing amount of cash to shareholders.
(6) Over the course of 2006-2007 we expect Oxy to secure additional Middle East projects, which could further boost long-term growth expectations.
OXY ADDS INTERNATIONAL OIL DEVELOPMENT GROWTH POTENTIAL TO OUR TOP SUPER-/LARGE-CAP PICKS
We see Occidental Petroleum as adding attractive low-geologic risk, international (Middle East and Latin America) oil development growth potential to our group of favorite super-/large-cap stocks. Other super/large-cap favorites include Canadian Natural Resources and Suncor Energy for oil sands exposure; Murphy Oil for deepwater exploration potential; XTO Energy and EnCana for unconventional natural gas growth onshore North America; Anadarko Petroleum as our "value" gas E&P pick; Valero Energy for US refining leverage; and Exxon Mobil as our low-beta portfolio balancer. All of our top picks are OP/A rated except for Anadarko which is IL/A rated, though recognized as our favorite IL/A-rated large-cap. Exhibit 1 ranks our top picks in order of preference.
KEY RISKS TO OUR FAVORABLE VIEW OF OXY
(1) Commodity prices fall into the $40s/bbl for oil (or lower). This risk clearly applies to almost all of the stocks in our coverage universe. Given supply-side constraints, we think a deep, global recession would likely be needed to cause a material reduction in energy commodity prices.
(2) Production growth/new projects disappoint. Again, a risk inherent to most upstream-oreinted companies we cover.
(3) Oxy abandons its financially-disciplined strategy. Given that Oxy management often refers to itself as "reformed alcoholics" from the perspective of financial discipline, we would be surprised to see the company fall off the wagon so to speak, especially as long as well-respected CFO Stephen Chazen is part of the top management team.
INTRODUCING 2006 QUARTERLY EPS ESTIMATES FOR OXY We are introducing 2006 quarterly EPS estimates for Occidental Petroleum of $3.29 (1QE), $3.54 (2QE), $3.62 (3QE), and $3.30 (4QE). There is no change to our full-year 2006-2010 EPS estimates. See Exhibit 2 for our summary financial model for Oxy.
Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Arjun Murti, Luis Ahn. |
