OXY (OP/A): Occidental Petroleum upgraded to OP given reloading of E&P portfolio
Goldman Sachs May 26, 2005
For investors looking for greater cyclical leverage than Exxon Mobil provides but with less risk than many of our E&P/domestic oil favorites, we have upgraded Occidental Petroleum to OP from IL and consider it our favorite of the medium-risk large-cap oils, just ahead of its closest peers Chevron and ConocoPhillips (both IL/A). In the context of our bullish oil macro outlook, we have heretofore focused on high-beta large-cap top picks like AHC, ECA, MUR, and SU, balanced by the low-beta XOM (all OP/A rated). We are comfortable adding to our top picks today, on further weakness, or even after a rally. We think a buying opportunity for CVX, which has lagged in 2005, could materialize later this year, nearer the closing of the pending Unocal deal. While we still have a favorable view of its long-term outlook, we have downgraded Devon Energy to IL from OP to make room for Oxy as a top pick. Please see our detailed 16-page report, "Occidental Petroleum: Upgraded to OP given reloading of E&P portfolio." If you are on our e-mail distribution list, a .pdf will be sent today.
OXY UPGRADED TO OUTPERFORM FROM IN-LINE
We have upgraded Oxy to Outperform from In-Line for the following reasons:
* We have an improved view of Oxy's risk/reward given what we believe to be the successful reloading of its E&P project portfolio, which should extend its period of recovery and improvement through at least 2010.
* We now forecast E&P production to grow at 5% per year from 2005-2010, above the large-cap oil sector average of 4.5%.
* We expect return on capital employed (ROCE) to be in the top quartile of industry overall during the above-normal portion of the cycle and at the high end of the domestic oil/E&P peer group on a "normalized" basis.
* We expect ROCE volatility to have been reduced to top quartile status, providing better downside protection versus other domestic oil/E&P companies.
* Balance sheet is on track to be net debt free in 2006, providing significant optionality to the benefit of investors.
INCREASED CONFIDENCE IN GROWTH AND RETURNS PROFILE KEY TO SHARES
Key company-specific catalysts for Oxy include the following: * We think Oxy will unveil a new production profile later in 2005 once it completes negotiations with Libya for re-entry to acreage suspended since 1986, which should enhance investor confidence in our new growth forecasts for Oxy. * Improved confidence that Oxy will generate acceptable rates of return in its new Middle East projects. * We note that outperformance in recent years by Oxy shares has come through steady strong results versus its peers, as opposed to any one high-profile catalyst driving its stock higher, which we think will be the case in the future as well. Oxy is not like Murphy Oil, where specific wells drive its stock up or down on a given day or week.
RISK/REWARD LOOKS ATTRACTIVE ON A RELATIVE AND ABSOLUTE BASIS
We have an improved view of Oxy's risk/reward and see its current share price as providing an attractive entry point for investors on an absolute basis and relative to the sector. We estimate 47% total return upside potential for the shares to a "1990s cycle" peak value of $102, with estimated free cash flow from our "super-spike" scenario providing an incremental 92% of upside potential for Oxy. By comparison, the large-cap integrated oil and E&Ps show corresponding upside of 27% and 64%. Oxy is currently trading at 4.4X 2006E and 6.9X 2007 normalized EV/DACF, which compares favorably with the large-cap integrated oil and E&Ps at 4.9X 2006E and 7.1X 2007N EV/DACF, especially after further adjusting for differences in ROCE and ROCE volatility.
KEY RISKS: COMMODITY CYCLE TURNS DOWN AND NEW PROJECTS DISAPPOINT
The key risks to our favorable view of Oxy include the potential for a sharp downturn in commodity prices and disappointing returns on its new projects. In terms of downside commodity risk, we believe Oxy's shares would hold up somewhat better than many of the other stocks we cover in the domestic oil, E&P, and R&M sub-sectors, because its ROCE volatility appears to be lower than that of its peers. The risk that new projects prove disappointing in terms of volumes and profitability is not, we think, unique to Oxy.
TO MAKE ROOM FOR OXY, WE HAVE DOWNGRADED DEVON ENERGY TO IN-LINE
We have downgraded Devon Energy to In-Line from Outperform to make room for Oxy in our portfolio of top picks (see Exhibit 1). Investors should not view this as reflecting any new concerns we have on the part of Devon's outlook, which we continue to see as favorable. Rather, this is purely a reflection of our view that Oxy has an even more favorable risk/reward than Devon at this time.
UPDATING ESTIMATES
We are updating our 2Q, 3Q, 4Q 2005, and full-year 2005E-2010N EPS estimates for Occidental Petroleum, which now stand at $2.11 ($2.06 before), $2.16 ($2.13 before), $2.16 ($2.12 before), $8.57 ($8.44 before), $11.29 ($10.12 before), $4.50 ($3.50 before), $4.85 ($3.57 before), $5.23 ($3.66 before), and $5.66 ($3.76 before), respectively. Our EPS adjustments reflect the company's recent developments such as acquisitions in the Permian Basin, signing of the Heads of Agreement to develop the Mulhaizna field in Oman, and progress in Qatar via its ISSD/ISND and Dolphin projects. We are updating our full-year 2006E-2010N EPS estimates for Chevron, which now stand at $7.27 ($7.40 before), $3.30 ($3.40 before), $3.52 ($3.62 before), $3.65 ($3.70 before), and $3.78 ($3.82 before), respectively. Our EPS adjustments reflect the pending acquisition of Unocal, estimated asset sales, and minor other adjustments. We are also updating our full-year 2006E-2010N EPS estimates for ConocoPhillips, which now stand at $17.11 ($17.00 before), $7.75 ($7.10 before), $8.07 ($7.30 before), $8.33 ($7.39 before), and $8.62 ($7.53 before), respectively. Our updated EPS estimates reflect its increased ownership stake in Lukoil, favorable adjustments to differentials and unit costs in the E&P segment, and minor other adjustments.
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. |
