Newfield Exploration (OP/A): Visible production profile calls into question discounted valuation
Goldman Sachs July 27, 2005
Shares of Newfield Exploration continue to be among our top picks, and we believe the company's returns-efficient diversification makes highly credible its case for mid- to high single-digit multi-year growth. With upcoming development projects in Malaysia, the Gulf of Mexico and the North Sea combined with longer-lived growth in the Mid-Continent and Rockies, we believe that Newfield's production profile looks increasingly more visible than that of other E&Ps. Newfield is our favorite of the conventional E&Ps as we believe its shares are highly undervalued considering above-average growth expectations. We see no reason why Newfield should not trade at least at an average cash flow multiple with other E&Ps and see 22% upside to a $51 estimated traditional peak value. We rate Newfield Outperform relative to an Attractive coverage view.
PRODUCTION GROWTH MORE VISIBLE AND DIVERSE
We believe that a high single-digit annual production growth is secure for the coming years, and we view positively management's expectations for 3%-8% growth for 2006 and 8%-15% growth for 2007. Management has historically been very conservative, putting out guidance for only the current year. In releasing out-year guidance, we do not believe there has been any deterioration of management discipline. Rather, for the first time, Newfield has enough new projects lined up over a period of years to make growth visible. The burden now shifts to Newfield management not only to meet its forecast but also to avoid spectacular declines in later years experienced by peers in the past such as Pioneer Natural Resources. We believe Newfield management is already attacking this potential longer-term question, and we do not expect exploration to wane.
We are assuming 6% growth in 2006 and 10% growth in 2007. We believe that Newfield is not assuming any meaningful additional exploration success in its estimates, meaning that there could be upside, especially to our numbers. We believe Newfield's growth will turn into strong cash flow, considering that the increases are coming from three attractive markets - the US, the North Sea and Malaysia. Because Newfield is spending capital in 2005 and 2006 for these projects - the company raised spending to $1.2 billion from $950 million this year to account for increased opportunities as well as service cost inflation - the company's free cash yield is understated in our view.
KEYS TO MEETING GROWTH EXPECTATIONS
(1) Executing developed market deepwater development schedule. Newfield has a slew of both development and exploration opportunities in the Gulf of Mexico (GOM) and North Sea. Rigel is expected to come online in October 2005 and add 16-17 MMcfe/d. Wrigley is expected to come online in mid-2006 and add 25 MMcfe/d. Grove in the North Sea is expected to come online in late 2006 and add more than 60 MMcf/d. Developments at Anduin and La Femme, two deepwater GOM wells, are likely planned for 2007 pending appraisal wells to be drilled late this year/early 2006. We would note that no reserves have yet been booked for Wrigley, Grove, Anduin and La Femme. When combined with additional new developments in China, Malaysia and at the Monument Butte field in the US, reserve bookings could be strong this year.
(2) Steady drilling and cost control from onshore "manufacturing" plays. Newfield continues to show success from drilling shallow gas wells in the Mid-Continent and oil wells at the Monument Butte field in Utah. Showing continued gradual production growth from these regions is key to both help smooth the company's overall production profile as well as, in the case of Monument Butte, gain greater acceptance for the company's Inland Resources acquisition. In the Mid-Continent, we see cost control as the greater risk, with increasing competition for services and people. In Utah, we believe the risk is potential volatility in well results. Both regions have additional exploratory opportunities, and we would note Newfield has become more active in Rockies natural gas exploration in the Williston Basin with Bill Barrett Corp. and in the Uinta Basin with Gasco.
(3) Malaysia. Newfield has three unique opportunities in Malaysia. PM 318 is the site of the company's current production, with incremental development opportunities at the Abu Cluster expected to add oil production in 2007. Second, the company is further along in defining development potential at PM 323. Already the East Belumut and Chermingat fields are expected to add about 17,000 bpd in net production in 2008. Two additional opportunities are pending appraisal wells. The third opportunity is Block 2C, an exploration play that could hold an estimated 200-500 million barrels of gross resource (Newfield has a 60% interest though it would bear 80% of the exploration cost). Newfield plans to drill a well in 2006, either in January or May. The block is located about 100 miles away from Murphy Oil's Kikeh discovery.
VALUATION
Newfield trades at 4.6X 2006 EV/debt-adjusted cash flow, versus 5.5X for other E&Ps. Given Newfield's increased diversification and production growth visibility, we do not believe it should trade at any discount. Parity with other E&Ps would imply 22% upside to a $51 price for Newfield shares. We also see 74% upside to a $73 super-spike adjusted peak value.
2Q 2005 ADJUSTED EPS ABOVE OUR AND CONSENSUS ESTIMATE
Newfield reported 2Q 2005 adjusted EPS of $1.05, higher than our estimate of $1.00 and First Call consensus estimate of $0.99. Reported EPS was $0.82 inclusive of a $30 million after-tax hedging loss. Oil production was in-line with expectations. U.S. gas production came in larger-than-expected at 585.7 MMcf/d versus our 563.3 MMcf/d. Newfield's realized international oil price was $51.95 per bbl versus our estimate of $44.50 per bbl, although given the relatively small amount of production internationally, this positive impact was muted. Other realized oil and gas prices were generally in-line. All-in costs were generally in-line at $20.57 per BOE versus our estimate of $20.49 per BOE, although production costs were slightly higher-than-expected at $4.44 per BOE versus expected $4.26 per BOE. Operating cash flow was $300 million, versus our $291 million estimate. Net debt/tangible capital is at 28%.
UPDATED ESTIMATES
We have updated estimates to reflect changes in production (a decrease in 3Q 2005 but increases for later periods), greater capital spending and other minor company adjustments. We now estimate 3Q 2005 EPS of $1.01 ($1.07 previously). We now estimate 4Q 2005 EPS of $1.19 ($1.16 previously). Our full-year 2005 and 2006 estimates are now $3.97 ($4.18 previously) and $4.75 ($4.64 previously), respectively. For 2007-10 (normalized) we now estimate $1.99 ($1.92 previously), $2.32 ($2.26 previously), $2.46 ($2.40 previously) and $2.63 ($2.59 previously), respectively. Exhibit 1 shows our summary financial model for Newfield.
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. |
