XTO (OP/A), PXD (IL/A): Upgrading XTO Energy to OP/A on Piceance deal with Exxon; lowering Pioneer to IL/A
Goldman Sachs June 30, 2005
We are upgrading shares of XTO Energy to Outperform from In-Line and lowering our rating on Pioneer Natural Resources to In-Line from Outperform, both relative to an Attractive coverage view. We view XTO's entry into Colorado's Piceance Basin as highly additive to the company's expected returns and resource base. By partnering with Exxon Mobil, XTO has access to high-quality acreage and the best technology in the region. We see the potential for 2.3 Tcfe of undrilled resource net to XTO from the Piceance and have increased our estimated traditional peak value by $5 per share to $41, representing 21% potential upside from the June 29 close. The Piceance adds to XTO's multiyear drilling inventory which we believe can generate greater organic production growth vs. peers. Our downgrade of PXD to IL is based on less confidence in its ability to profitably grow production vs. OP-rated E&P companies.
UPGRADING XTO TO OUTPERFORM ON ATTRACTIVE DEAL WITH EXXON IN PICEANCE
XTO announced it has farmed into about 35,000 acres in the Piceance Basin previously 100%-owned by Exxon Mobil. As we noted in our June 23 report, "Piceance Basin: Potential material upside for super- and small-caps," we believe there is significant resource potential and value not being afforded in the stocks of the major Piceance players - EnCana, Exxon Mobil and Bill Barrett. By entering the Piceance, we add XTO Energy to this list. There are four main reasons why we believe this deal should drive shares of XTO Energy higher.
(1) From what little was disclosed in XTO's press release, the terms look to be surprisingly favorable in an environment where companies are paying large up-front sums for acreage. Much of the consolidation among E&P companies has been in unconventional gas basins, with significant sums being paid simply for acreage, let alone highly-prospective acreage. We believe that in this transaction, XTO is entering the Piceance at more favorable terms than other unconventional gas transactions. While some will wonder if Exxon's willingness to farm-out the acreage on seemingly attractive terms to XTO suggests that the acreage is of meaningfully lower quality, we note that Exxon has retained a 50% working interest in the XTO-operated acreage. We doubt Exxon would be willing to invest any capital in acreage it did not think was prospective. Furthermore, Exxon Mobil, and for that matter most of the super major oil companies, are no longer geared for the mass drilling campaigns inherent to unconventional gas plays. We see Exxon's bringing XTO in as a partner as similar to what it has done on acreage in Western Canada with Apache.
(2) We see 21% upside potential to an adjusted $41 estimated traditional peak value for XTO. We believe the present value of the Piceance deal adds $5 per share to traditional peak value for XTO and $3 per share to mid-cycle value. These assume that XTO's acreage is about half as attractive as the rest of Exxon's in terms of gas in place with a similar recovery rate to Exxon's. We see 2.3 Tcfe of undrilled recoverable resource potential for XTO, which comes out of the formerly 35 Tcfe of recoverable resource on Exxon's acreage position prior to the transaction. Please see the attached exhibit which summarizes acreage position and recoverable resource potential for the main Piceance Basin players. We believe our assumptions for XTO and other Piceance Basin companies could prove to be highly conservative.
(3) XTO is one of the companies which has multiyear drilling inventory and like EnCana is increasingly positioning itself in the major unconventional gas basins - East Texas, Piceance, Barnett Shale, San Juan/Raton - in addition to longer-lived conventional drilling. We continue to believe that companies that have visible profitable resource will show higher organic growth, better stock price performance and will see greater likelihood of consolidation.
(4) In our April 5, 2005 report on XTO titled, "Best in class and premium deserved," we argued that the basis for our In-Line rating on XTO shares was because XTO's premium valuation versus peers had moved up ahead of its returns advantage versus peers. However, in the last three months, the stock has lagged (up 8% vs. up 16% for other large-cap E&Ps). More importantly, we believe this deal will help boost XTO's returns advantage over time.
XTO DEAL IS POSITIVE FOR OTHER PICEANCE PLAYERS
We continue to recommend shares of EnCana Corp. and Bill Barrett Corp. (both OP/A) and believe that XTO's partnership with Exxon is positive for all players in the basin. We believe that XTO's entry will improve the visibility of the basin as a whole. More importantly, it seems increasingly less likely that Exxon can keep its unique drilling technology proprietary for long, meaning that recovery rates across the basin could improve at quicker-than-expected levels. (Investment funds affiliated with The Goldman Sachs Group, Inc. have a principal investment in Bill Barrett Corp. (BBG). As a result of its position in BBG securities, The Goldman Sachs Group, Inc. may be deemed an affiliate of BBG.)
LOWERING RATING ON PIONEER NATURAL RESOURCES TO IN-LINE FROM OUTPERFORM
We view the near- and medium-term organic growth potential for Pioneer Natural Resources less favorably relative to other E&Ps. We believe that management may continue to struggle to show organic growth into 2006 as the company faces declines from the Gulf of Mexico that may not be able to be offset by exploration success and growth from the Raton Basin and the company's recent acquisition in the Permian Basin/South Texas. While we still believe that there is upside to the sum-of-the-parts of Pioneer's reserve base, we see greater upside for other E&P companies and believe that the potential for shareholder activism may be reduced by Pioneer's existing use of volumetric production payments. We also believe that Street estimates for 2Q 2005 are too high (we project EPS of $0.42 for PXD in 2Q 2005, 37% below the First Call consensus of $0.66), in part considering expected lower production due to the May 15 fire at one of Pioneer's gas plants (for which the company is insured, though the company may not receive proceeds until later this year).
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. |
