ChevronTexaco (IL/A): Least expensive of US super-cap oils due to investor concern over Unocal deal Goldman Sachs April 29, 2005
We believe investors have put ChevronTexaco in the "penalty box" for its acquisition of Unocal, as the shares have significantly lagged the sector this year. With CVX now trading on par with many E&Ps and domestic oils, the shares appear to be very inexpensive. The issue is that with the Unocal deal not slated to close until later this year, CVX's stock price performance could remain lackluster. Although we do not consider the slight shortfall versus consensus for 1Q05 to be of any significance fundamentally, psychologically it can serve to keep a lid on relative stock price performance. With that said, reversion to the mean we believe works for the super-cap oils. CVX has lagged and is inexpensive. Longer-term investors we think should be taking a long, hard look at its shares. We retain an In-Line rating relative to an Attractive coverage view.
WITH LAGGING SHARE PRICE PERFORMANCE, CVX SHARES LOOK VERY INEXPENSIVE
ChevronTexaco is currently trading at just 5.7X and 4.7X 2005E and 2006E EV/DACF, respectively, which is well below the corresponding 6.6X and 5.6X super-cap integrated oil average and actually on par with many of the domestic oil and large-cap E&Ps (see Exhibit 1). Chevron, in fact, trades at parity with Marathon Oil (5.7X/4.6X) and incredibly, to us, at a discount to Kerr McGee (6.8X/5.0X). Such an inexpensive valuation, in our view, is unlikely to persist over the long run.
INVESTORS SKEPTICAL THAT UNOCAL ACQUISITION MAKES SENSE FOR CHEVRON
We believe investors are skeptical as to the strategic and financial logic of the Unocal transaction and have effectively put Chevron in a "penalty box" of sorts pending greater confidence that the deal makes sense. Part of the concern likely stems from broad macro concerns about a potentially slowing economy and the negative impact that could have on the oil sector. Even though it will mostly be using its elevated share price to acquire Unocal's elevated shares (the transaction is 75% stock/25% cash), investors nevertheless appear concerned that Chevron is implicitly assuming at least a $40/bbl (or higher) long-term WTI oil price if it is to generate attractive returns on capital from the acquisition. While we are very bullish on the outlook for commodity prices over the next few years, there is no change to our view that over very long periods of time, oil remains a commodity business where excess returns get competed away. We believe investors have come to expect the super-cap oils to forgo commodity price-dependent investments and focus almost exclusively on enhancing return on capital employed (ROCE) at low normalized commodity prices. Whether Chevron should be willing to assume higher commodity prices or not (management has denied it is using a higher long-term price deck to justify the Unocal acquisition) is not the issue we wish to debate here. Rather, we believe Unocal has a large amount of inherently lower return assets that we believe Chevron could consider divesting. Given the robust commodity environment that exists today, we believe the company could receive favorable prices for asset sales, which could be used to pay down a large portion of the acquisition capital thereby lowering the oil price needed in order to generate attractive returns. In the case of Unocal, we believe most of its North America E&P asset base with the exception of its deepwater Gulf of Mexico properties and perhaps select assets elsewhere should be divested. We are somewhat concerned that Chevron has perhaps set a low bar on asset sales at $2 billion or more. In our view, a figure close to three or four times that amount would make sense in terms of cleaning up Unocal. The attraction of Unocal has always been its Asian gas assets, its investment in the ACG field in Azerbaijan, and increasingly its deepwater Gulf of Mexico portfolio. We believe such assets will prove to be a strategic fit for Chevron. If the company uses the current robust commodity environment to sell assets, generate free cash flow, and pay down acquisition capital the Unocal deal can also make financial sense.
KEY CATALYSTS LACKING NEAR-TERM, PATIENCE LIKELY REQUIRED
For investors that are neutral-to-bullish on the Unocal acquisition, the question still remains as to when the market will stop penalizing Chevron for the transaction. Given bad memories many investors still bear regarding the first year of its merger with Texaco, we believe there will be hesitation to give the company the benefit of the doubt ahead of time, even though the integration of Unocal is likely to be much more manageable given its smaller size. We are not sure if investors have to wait until the deal closes and the company demonstrates it is realizing value on the transaction. In reality, there is likely some level of valuation discount where one would be willing to wait it out. We may be getting close to that level, though our continued In-Line rating suggests we have not quite crossed that bridge yet.
1Q 2005 RESULTS BELOW EXPECTATIONS
ChevronTexaco reported 1Q 2005 EPS of $1.28, which was below the $1.38 First Call consensus and our $1.50 forecast. The key variances with our estimate were lower R&M earnings and higher corporate charges. We do not consider the miss to be material. Note, the company had previously guided to higher corporate charges, but we thought management was being too conservative. As it turns out, management was much closer to the mark than were we. R&M earnings, especially outside of the US, can be notoriously volatile and difficult to forecast. In 1Q 2005, weak retail gasoline margins and both planned and unplanned refinery downtime drove the shortfall relative to our expectations. We do not consider either of these issues to be material.
UPDATING ESTIMATES
We are updating our EPS estimates for 2Q, 3Q, and 4Q 2005, which now stand at $1.64 ($1.77 before), $1.61 ($1.70), and $1.59 ($1.70), respectively. Our new full-year EPS estimates are $6.12 ($6.67 before) for 2005, $7.40 ($7.65) for 2006, $3.40 ($3.50) for 2007, $3.62 ($3.70) for 2008, and $3.70 ($3.90) for 2009, and $3.82 ($4.04) for 2010. The primary change we have made is to reflect higher corporate charges than we had previously assumed for all periods forecast. We have also slightly revised down E&P production volume forecasts over the full forecast period. See Exhibit 2 for a summary model for ChevronTexaco.
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. |
