Occidental Petroleum (IL/A): Greater clarity on E&P growth outlook likely needed to regain valuation premium April 26, 2005 Goldman Sachs
We continue to believe Occidental Petroleum (Oxy) is well positioned to benefit from our bullish commodity outlook, with the shares having meaningful additional upside potential in the context of our Attractive coverage view. We rate Oxy In-Line only because we see even greater upside potential in other oil equities. Furthermore, we see 2005 as a transition year for Oxy and believe greater visibility in its long-term E&P growth profile will be needed to drive further relative share price outperformance and a widening of a valuation premium that has recently narrowed. Key catalysts/milestones include potential Permian Basin and other acquisitions, increased activity in Libya, and securing additional growth projects most likely in the Middle East. 2005
A TRANSITION YEAR FOR OXY
We believe 2005 represents a transition year for Oxy's E&P business following a strong stretch from 1999-2004 where it delivered mid-to-high single digit volume growth at sector-leading capital costs. Between 1999-2004, Oxy's profitability dramatically improved versus its peers and the company was transformed from a fourth quartile, struggling domestic integrated into one of the most successful "independent" oil companies. Key areas of future opportunity include acquisitions in the Permian Basin, re-entry into Libya, and other projects being pursued most likely in the Middle East. We are encouraged by management's deliberate and patient strategy of adding projects. This enhances the likelihood that Oxy's superior profitability versus its peers can be sustained in the years to come. In our view, Oxy's long-lived asset base allows for the patient and returns-focused strategy given the inherent lower decline rates (hence less urgency to spend aggressively and potentially unwisely to replace production). On the acquisition front, Oxy made a small purchase in the Permian Basin in 1Q 2005 and has announced that it expects to secure a larger Permian package most likely in the next month or so. Together, the deals are expected to boost production by around 25,000 boe/d (or 4.4%). The acquisitions look to be complimentary to Oxy's existing core asset base and are likely needed to ensure the continuation of limited declines in its base production. Oxy's development portfolio currently looks limited, as the Dolphin project and re-entry into Libya appear to be the only identifiable major projects. First gas from Dolphin is expected in late 2006, with estimated gross production at 2 Bcf/d in the first phase. A possible second phase of the project could add an incremental 1 Bcf/d in production in the 2009-2010 time frame. Oxy holds a 24.5% interest in the project. In terms of a re-entry into Libya (for currently producing fields), management noted that a final agreement with the Libyan government could occur at any time. Company management has stated that it is in discussions for other unnamed projects in the Middle East.
OXY VALUATION PREMIUM HAS NARROWED VERSUS PEERS
Oxy shares currently trade at 6.2X and 4.9X EV/DACF (enterprise value divided by debt-adjusted cash flow) for 2005E and 2006E, only slightly above the domestic oil/E&P peer group average of 5.8X and 4.7X, respectively. We believe Oxy should trade at a premium to its domestic oil/E&P peers, given that it appears to have a superior E&P asset base in terms of being profitable, free cash generating, and long-lived. The narrowing of its valuation premium is likely a function of the Street taking a bit of a wait-and-see attitude toward the re-loading of its E&P growth portfolio that is occurring in 2005. Exhibit 1 shows comparative valuation and return on capital employed (ROCE) for Oxy and its domestic oil/E&P peer group.
TRADING OUTLOOK: 12% DOWNSIDE RISK TO TRADITIONAL MID-CYCLE VALUE VERSUS 84% UPSIDE TO SUPER-SPIKE-ADJUSTED PEAK LEVELS
We estimate Oxy shares have 12% downside risk to a $62 traditional mid-cycle value and 84% upside potential to a super-spike-adjusted peak value of $130. This compares to the domestic oil/E&P peer group showing on average 4% downside risk and 85% upside potential, respectively. Excluding super-spike optionality, we see Oxy shares as having 5% total return upside to traditional peak levels.
1Q 2005 RESULTS ABOVE EXPECTATIONS, PRIMARILY ON CHEMICALS EARNINGS
Oxy reported adjusted 1Q 2005 EPS of $2.13, ahead of the $1.99 First Call consensus and our $1.95 forecast. We attribute the majority of the favorable variance to higher-than-expected chemicals earnings. E&P earnings were also higher than expected, with in-line production levels (565,000 boe/d actual and forecast) and better-than-expected realized prices.
UPDATING ESTIMATES
We are updating our 2Q, 3Q, 4Q, and full-year 2005 EPS estimates for Oxy, which now stand at $2.06 ($1.96 before), $2.13 ($2.00 before), $2.12 ($2.04 before), and $8.44 ($7.95 before), respectively. We are also updating our 2006 and normalized 2007, 2008, 2009, and 2010 EPS estimates which now stand at $10.12 ($10.00 before), $3.50 ($3.45 before), $3.57 ($3.52 before), $3.66 ($3.61 before), and $3.76 ($3.71 before), respectively. Our EPS adjustments reflect higher assumed earnings from chemicals, estimated impact from the Permian Basin acquisitions, and minor other adjustments. See Exhibit 2 for a summary model of Oxy.
I, Arjun Murti, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
