Petro-Canada (U/A): Premium valuation more than factoring in new 2006-08 projects
Goldman Sachs July 28, 2005
Petro-Canada is showing improvements in its commitment to and results from exploration, and we believe 2005 will be the trough year of production declines. We remain concerned by Petro-Canada's higher E&P cost structure versus its peers, as well as its premium valuation versus domestic oils. Petro-Canada trades at 9.0x 2007 mid-cycle EV/debt-adjusted cash flow versus 7.7x for other domestic oils, a premium that more than accounts for its higher growth from short-lived projects during 2007 and 2008. Among domestic oils, we prefer Amerada Hess, Occidental Petroleum, Suncor Energy and Murphy Oil (all OP/A), and we rate Petro-Canada Underperform relative to an Attractive coverage view.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Project startups during 2006-08 and confidence in long-term growth. We believe that 2005 will be the trough year of production declines, with 4% net production growth in 2006 (led by White Rose), 11% production growth in 2007 (White Rose and Buzzard) and 9% in 2008 (Buzzard). Longer-term opportunities include the Hebron project in Hibernia and the Fort Hills oil sands project, both of which are in the planning stages but not fully defined. Execution of these projects without major cost overruns is key to establishing confidence in Petro-Canada's production profile.
(2) Exploration. Petro-Canada took a large step forward in returning to exploration with initial discoveries in the North Sea and Libya and the announcement of major prospects to be drilled this year in Tunisia and Algeria. We believe that significant exploration success is necessary to prevent meaningful production declines in 2009 once key North Sea and East Coast projects are online. We believe that 2006 will be a key year for exploration, and further success could improve production visibility. Without exploratory success (and even with success), Petro-Canada may continue to seek out acquisitions to smooth production growth, especially in North America, where we believe expected growth from the Powder River Basin is dwarfed by declines from conventional production.
(3) Cost structure. We continue to see Petro-Canada's E&P costs above peers and trending higher. We would note that Amerada Hess - which trades at a discounted 5.9x 2007 mid-cycle EV/DACF, partly because of its alleged high E&P cost structure -showed 2Q 2005 E&P cash costs of $8.56 per barrel of oil equivalent (BOE), versus $11.30 per BOE for Petro-Canada. Petro-Canada has higher pre-hedge price realizations and lower DD&A. In 2004, however, Amerada Hess's finding and development costs improved to normal levels from the bottom tier. This year and 2006 are key tests for the profitability of Petro-Canada's exploration program, measured by finding and development costs. We believe these key elements of cost structure will determine whether Petro-Canada will be able to maintain its returns advantage relative to its peers.
2Q 2005 RESULTS BELOW OUR EXPECTATIONS BUT IN-LINE WITH CONSENSUS
Petro-Canada reported 2Q 2005 operating and financial results in line with expectations. Adjusted EPS of US$1.60 was below our estimate of $1.80 but in-line with First Call consensus, reflecting lower than expected production and higher unit costs partially offset by higher than expected price realizations. Operating cash flow of $751 million was lower than our estimate of $850 million. Costs were higher quarter-over-quarter, with estimated lease operating expenses rising to $7.51 per barrel of oil equivalent (BOE) of net production from $6.75 per BOE in 1Q 2005 and DD&A rising to $8.13 per BOE from $7.84 per BOE in 1Q 2005. Production of 322.6 MBOE/d was slightly above our estimate of 347.2 MBOE/d. Price realizations of $48.88 per barrel for oil and $5.67 per Mcf for natural gas were above our estimates of $46.38 per barrel and $5.41 per Mcf, respectively. Downstream EBITDA of $5.14 per BOE of throughput was below our estimate of $8.11 per BOE, reflecting refining margins of $14.53 per BOE versus our estimate of $17.11 per BOE along with lighter than expected volumes. Net debt/tangible capital was 26% at quarter-end.
UPDATING ESTIMATES
We are updating our quarterly 2005 and full-year 2006 EPS estimates primarily to reflect our revised outlook for production, price realizations, and unit costs. Our 3Q 2005 EPS estimate is now $1.55 ($1.66 previously), our 4Q 2005 EPS estimate is now $1.53 ($1.64 previously), and our full-year 2005 EPS estimate is now $6.03 ($6.45 previously). Our full-year 2006 EPS estimate is now $7.04 versus $7.31 previously. There are no changes to our 2007-2010 (normalized) 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. |
