Kerr-McGee (IL/A): Realizing resource upside from the Westport acquisition remains key
Goldman Sachs July 28, 2005
We continue to rate Kerr-McGee shares In-Line relative to an Attractive coverage view as we see greater relative upside in our Outperform rated stocks. In our view, despite the recently announced restructuring plan that improves Kerr-McGee's ROCE both near-term and on normalized commodity prices, we remain concerned that its ROCE advantage will regress back to its historic sub-standard performance via future acquisitions or excessive spending. We believe what is lacking in its E&P portfolio is a visible and attractive resource base through which Kerr-McGee can not only offset production declines but also fuel growth. In our view, the Westport acreage can provide that opportunity if Kerr-McGee can realize the resource upside it claimed to have at the time of the acquisition. Given lack of visibility on the ultimate outcome, we remain skeptical of the sustainability of its improved ROCE.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Drillbit program. Given poor drillbit results in 2004, we believe it is critical for Kerr-McGee to deliver improved results in 2005. We are encouraged by management's indication on the conference call today that Kerr-McGee is on-track to replace at least this year's produced barrels. We currently estimate Kerr-McGee's 2005 reserve replacement ratio (RRR) to be 130%, though given management's comments our estimate may prove to be conservative. A 130% RRR implies a $12 per BOE finding and development (F&D) cost. We believe the key to Kerr-McGee's long-term potential as a "pure-play" E&P company is to successfully capture the resource upside on the Westport acreage via exlpoitation activities. Given Kerr-McGee's short reserve life even after the announced asset sales program (discussed below), we believe it is critical for Kerr-McGee to establish a consistent and dependable source for adding to its resource base instead of relying on exploration success or potential future acquisitions. If Kerr-McGee can consistently add at least 50 million BOE annually--or 300 million BOE cumulatively--over the next several years, we would view the acquisition to have been a success.
In terms of exploratory/appraisal wells for the quarter, Kerr-McGee will be active in the deepwater Gulf of Mexico (Nansen, Conquest, and Covington), Gulf of Mexico shelf (Cadillac, and Seminole), offshore Brazil (block BMC 7, BMC 30, and BMC 32), as well as in Angola, Alaska, and China.
(2) E&P asset sales. As part of the financial restructuring plan announced on April 14 of this year, Kerr-McGee management indicated it will be selling 20%-25% of its production (roughly 70,000 - 90,000 barrels per day) and 10%-15% of its reserves (roughly 125-185 million BOE) from the US onshore, Gulf of Mexico shelf, and UK non-operated assets. We estimate that this will have a favorable effect on Kerr-McGee's E&P portfolio given the inherent high-cost and short reserve life of the assets. In our view, a successful asset sales program would entail after-tax proceeds of at least $2 billion, improvement in proved developed reserves to production (PD R/P) ratio to roughly 7 years, and lower total unit costs of at least $1.50 per BOE. In terms of timing of the asset sales, management expects bids to be submitted in 3Q, with completion of the asset sales by year-end and proceeds to be used to pay down debt.
(3) Spin-off or sales of its chemicals business. Management has indicated that sometime in 3Q a decision will be made on whether to spin-off or sell its chemicals business. We continue to have a favorable view of the chemicals business given consistent cash flow generation and robust returns and would have preferred Kerr-McGee not divest of its chemical assets. However, with management firmly down the path of spining-off or selling the business, we would view a $1.7 billion (pre-tax) value to be reasonable. 2Q 2005
RESULTS WELL AHEAD OF EXPECTATIONS
Kerr-McGee reported adjusted 2Q 2005 EPS of $2.65, ahead of the $2.35 First Call consensus and our $2.29 forecast. The positive variance between reported results and our expectations was driven by lower-than-expected corporate and interest charges and by higher-than-expected realized prices in E&P.
UPDATING ESTIMATES
We are updating our 3Q, 4Q, and full-year 2005 EPS estimates for Kerr-McGee, which now stand at $2.51 ($2.44 previously), $2.72 ($2.67 previously), and $10.27 ($9.78 previously), respectively. Our updated EPS estimates reflect actual 2Q results, updated E&P production profile, lower corporate expenses, and minor other adjustments. We have made no change to our 2006-2010 EPS estimates.
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. |
