Occidental Petroleum (OP/A): Super-major like returns and above-average growth at domestic oil/E&P valuation - Goldman Sachs - April 25, 2006
We maintain an OP/A rating on Occidental Petroleum as we continue to believe that it is on-track to deliver above-average E&P production growth through 2010 (6%+ CAGR) while maintaining super-major-like profitability, yet its shares trade at parity to the domestic oil/E&P average of 5.7X 2007E EV/DACF. Having said that, with natural gas-levered E&Ps falling out of favor in recent months, coupled with strong year-to-date Oxy share price performance, we see greater upside today in our top gas E&P picks XTO Energy (OP/A), Newfield Exploration (OP/A), and Anadarko Petroleum (IL/A). We see upside to "traditional" peak values--consistent with discounting $45/bbl long-term WTI oil--of 6% for Oxy ($110 per share) and 30% on average for XTO, Newfield, and Anadarko. On an absolute basis, we see 37% upside to a $143 "super-spike"-adjusted peak value for Oxy, which implies $60/bbl long-term oil.
OXY'S LONG-TERM POSITIONING FAVORABLE, ALTHOUGH WE SEE MORE UPSIDE IN GAS E&Ps TODAY With Oxy shares having performed in the top quartile within our overall coverage universe year-to-date (33% total return versus 19% for the XOI index), we now see greater upside in our favorite gas E&Ps XTO, Newfield, and Anadarko. In our view, the near unanimous view that gas prices could fall below the $6.50-$7.00/MMBtu floor we think will be maintained has created a particularly favorable risk/reward for natural gas-oriented E&P equities (for more details see our note published on April 20, 2006, "Energy Investment Strategy trading update -- Energy has potential to "three-peat" in 2006 despite inevitable volatility"). We see on average 30% upside to "traditional" peak values for XTO, Newfield, and Anadarko, relative to Oxy showing 6% upside to our $110 "traditional" peak value, which assumes a $45/bbl long-term WTI oil price.
Notwithstanding a more favorable risk/reward for gas E&Ps today, we believe the combination of Oxy's growth potential in the Middle East, high free cash flow generating US operations, super-major-like risk-adjusted profitability, and inexpensive absolute valuation can be attractive for long-term investors. Should investors ratchet-up long-term WTI oil price expectations--which we believe is likely over the next 12-18 months--we would have greater confidence in Oxy trading towards our $143 (+37%) "super-spike"-adjusted peak value given its long-lived asset base than most other companies under our coverage universe.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Exploration and additional enhanced oil recovery (EOR) projects particularly in the Middle East. At its February 23 analyst meeting, Oxy management indicated that new growth opportunities particularly in the Middle East and Libya could boost its E&P production growth to 10%+ CAGR versus a base-case estimate of roughly 6%, which assumes no new exploration success or EOR projects. With exploration in Libya and the newly awarded Block 54 in Oman expected to ramp-up through 2006, we believe investor confidence in the upside production growth scenario could increase over time. Note, while the magnitude of resource discovery is key to profitability given the high government take in the Middle East, we view it highly unlikely that Oxy will have zero exploration success in both Libya and Oman. In terms of profitability, we believe Oxy's strong track-record of delivering on growth projects at robust returns (25%+ ROCE even during a low oil price environment) does not support investor concerns that new Middle East projects could generate "cost of capital" (or lower) returns. Beyond exploration, management has also highlighted new potential EOR projects in the Middle East--currently in preliminary discussions with host countries--that could unfold over the next 1-2 years.
(2) Use of free cash. Despite the acquisition of Vintage and peak capital spending in 2006, we estimate that Oxy's net debt (i.e., total debt minus cash balances) will approach zero by year-end 2006 assuming, among many factors, $1 billion in net asset sales proceeds and $3 billion in share repurchases. Should commodity prices remain robust, as we expect, and once the current 30 million share repruchase program is completed, we would not be surprised if management expands its buyback program. Note, even with our expectation that CAPEX will hover above $3 billion in 2007, we estimate Oxy's 2007E free cash yield to be 10%.
(3) Resolution of Ecuador's oil reform bill. We estimate that should Ecuador's recently passed oil windfall profits tax law be put in effect, it could lower Oxy's overall net income and cash flow by 4% and 3%, respectively. Note, the unilateral decision by the government of Ecuador to impose the new law violates the US-Ecuador Bilateral Investment Treaty. In our view, further arbitration or negotiations are likely although the best-case scenario will still likely involve a meaningful increase in government take.
(4) Production from Vintage properties. Given the natural fit between Oxy's core competencies and Vintage assets in California, Latin America, and Yemen, we believe Oxy will be able to integrate Vintage properties quickly and efficiently. In our view, a key data point to watch for in particular would be production from Argentina, where management has guided to double-digit growth over the next several years. We estimate current production from Argentina to be about 40,000 BOE/d.
(5) Arbitration with Nexen over properties in Yemen. On April 12, Nexen announced preliminary results of arbitration of Block 51 in Yemen, where the International Court of Arbitration found Nexen in breach of an obligation to offer Oxy the right to acquire a 50% interest in the area. Although monetary damages have not yet been determined, our very preliminary modeling suggests Oxy could be awarded up to $100 million, which is an estimated present value of future free cash from Block 51 minus Nexen's share of capital spending.
1Q 2006 RESULTS AHEAD OF EXPECTATIONS Oxy reported adjusted 1Q 2006 EPS of $2.83, ahead of both the $2.74 First Call consensus and our $2.77 forecast. The positive variance was largely driven by better-than-expected earnings from chemicals. Higher than expected 1Q 2006 E&P volumes were offset by lower realized liquids prices and higher unit costs--primarily depreciation--relative to our expectations.
UPDATED ESTIMATES We have updated our full-year 2006-2010 EPS estimates for Oxy, which now stand at $12.05 ($12.00 before), $14.05 ($14.20 before), $6.70 ($6.90 before), $7.55 ($7.70 before), and $8.45 ($8.65 before), respectively. Our updated EPS estimates reflect actual 1Q 2006 results, higher assumed chemicals earnings, higher assumed DD&A charges in E&P, and minor other adjustments. Our respective 2Q-4Q 2006 EPS estimates of $2.91, $3.16, and $3.17 remain unchanged as higher assumed E&P production volumes and chemicals earnings were offset by higher unit cost assumptions. See Exhibit 1 for comparative valuation. See Exhibit 2 for a summary model of Oxy.
Goldman Sachs & Co., and or one of its affiliates, is acting as financial advisor to Apache Corp in the proposed acquisition of BP's producing properties on the Outer Continental Shelf of the Gulf of Mexico. Goldman Sachs & Co., and or one of its affiliates will receive a fee for its financial advisor role.
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. |
