Western Gas Resources (U/A): Company guidance not in sync with Big George success Goldman Sachs May 05, 2005
We continue to see Western Gas Resources as the highest risk of the unconventional gas companies, as we have greater confidence in other unconventional gas basins relative to the Powder River Basin. We believe that Western Gas can be revalued higher if the Big George works according to initial expectations, though we believe that company guidance for 2006 is not consistent with Big George success. Western, as with Ultra Petroleum (IL/A) and Questar Corp. (OP/A), should benefit from expected positive developments in the Pinedale Anticline. The midstream business continues to provide free cash flow, and although the company must show strong gathering and processing volume growth in the remaining quarters to avoid reducing guidance, we do not believe the existence of the midstream restrains valuation of the upstream. We rate Western Underperform relative to an Attractive coverage view.
TOO EARLY TO DECLARE THE BIG GEORGE WORKING IN OUR VIEW
We believe that company guidance for 2006 for CBM production is not consistent with the ability to declare the Big George a success relative to initial modeling. Western's gross production of 97 MMcf/d from 748 producing wells represents just 130 Mcf/d per well, with none of the wells in decline and a very small amount (an estimated 40 or so wells at All-Night Creek) at plateau and nearing decline. Given the expectation for a Big George well to reach a plateau rate of 300-350 Mcf/d within a year and stay at that rate for 30 months, the 748 wells currently producing should rise to at least 180 MMcf/d gross or 72 MMcf/d net in 2006. This level is already at to above the midpoint of company guidance for 2006 (assuming the Wyodak declines 25-30% in 2005 and 2006), without any additional wells currently dewatering beginning to produce. This tells us that either: (a) company guidance is conservative for 2006, which we are reflecting in our estimates by assuming 2006 CBM production growth of 15% versus guidance of 5-10%; or (b) the Big George is not presently delivering results consistent with expectations. While it is possible that the thicker sections of the Big George have yet to come online, it seems nevertheless too early to declare the Big George a success relative to initial expectations.
PINEDALE IS WORKING AND A CATALYST, THOUGH MORE UPSIDE AT ULTRA AND QUESTAR
We believe that positive developments from the Pinedale Anticline will continue to benefit Western Gas, though we see greater upside from Pinedale developments at Ultra Petroleum and Questar Corp. We believe that there is a high probability that Ultra will receive approval for downspacing on most of the Pinedale Anticline to 10 acres at its hearing on May 10, given that 10-acre spacing has already been approved at neighboring Jonah field. We are already valuing Ultra, Questar and Western assuming 10-acre spacing. We are not assuming any success from deeper horizons in the Pinedale, and Questar's deep test which should resume shortly could be a catalyst. Additionally, if operators in the Pinedale can efficiently accelerate drilling there are significant present value gains considering the years of 10-acre drilling locations.
WE DO NOT BELIEVE MIDSTREAM IS NEGATIVELY IMPACTING VALUATION
While in the case of Questar we argue that the E&P business is being undervalued because of the company's historic midstream/utility investor base, we do not believe this to be the case at Western. We assume about 8.0x mid-cycle EV/EBITDA valuation for the company's midstream business, which backs into an implied 8.3x 2006 EV/debt-adjusted cash flow multiple versus 8.3x for Questar, 11.4x for Quicksilver Resources and 12.0x for Ultra Petroleum. We believe that Quicksilver and Ultra deserve their premiums due to greater confidence in growth, returns and free cash flow from the Pinedale Anticline, Barnett Shale and Horseshoe Canyon. We believe that Western shares can be revalued higher. However, the Big George has to be successful, and we see greater risk to this success than for other basins. The controversy over how much value should be in Western shares for the Big George, not the existence of the midstream business, is what is restraining Western shares in our view.
1Q 2005 EPS IN-LINE WITH CONSENSUS
Western reported 1Q 2005 financial and operating results slightly below expectations. EPS was $0.43, though $0.47 after adjusting for non-cash derivative loss. This was below our estimate of $0.55 but in-line with $0.46 First Call consensus. Operating cash flow of $81 million was lower than our estimated $87 million. Production of 164 MMcf/d was slightly below our estimate of 167 MMcf/d, while realized natural gas price of $4.14 was above our estimate of $3.94. Midstream EBITDA was $55 million versus our estimate of $60 million due to lower gathering volumes. All-in unit E&P costs of $17.43 were above our estimate of $15.56, as lease operating expense and DD&A were higher than expected. Net debt was $393 million at quarter-end, with net debt/tangible capital at 36%.
UPDATING ESTIMATES
We are updating our 2Q 2005, 3Q 2005, and full-year 2005 EPS estimates to reflect the 1Q 2005 actual results and minor adjustments to our forecasts for production and costs (mainly higher DD&A). We now estimate 2Q 2005 EPS of $0.45 ($0.47 previously), 3Q 2005 EPS of $0.57 ($0.56 previously), and full-year 2005 EPS of $2.15 ($2.28 previously). There are no changes to our 4Q 2005 or 2006-2010 EPS estimates.
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: Brian Singer, Arjun Murti. |
