Western Gas Resources (U/A): Uptick in production with Powder confidence, exploration key catalysts Goldman Sachs August 04, 2005
We continue to believe that Street confidence in production growth and free cash flow from the Powder River Basin is the key catalyst for shares of Western Gas Resources. We believe that fundamentals from other unconventional gas basins are superior to the Powder due to greater confidence in well performance and greater free cash flow, though we note that Western's 2Q E&P results were in-line to better than expected. We believe that Western's production will grow at rates above its guidance next year and that growing Big George production will exceed declining Wyodak production around 1Q 2006. However, due to lower expected returns and free cash flow we see greater upside from other E&Ps. We rate Western Underperform relative to an Attractive coverage view.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Well performance in the Powder River Basin. Production in the Big George was generally in-line with expectations, while the Wyodak declined during the quarter at a lower rate than in previous quarters. We expect the Big George to continue to grow, but anticipate the Wyodak will resume a greater decline rate. Despite this, we see total Powder River Basin production growing 14% in 2006 and total company production growing 23%, both above company guidance. We believe that wells today are producing at levels that are below expected Big George averages, though the company contends that initial wells were drilled in thinner coals and therefore should exhibit below-average well performance. This will be tested in 2006 and 2007, in our view.
(2) Cost structure. While we believe that Western Gas will show production growth levels in the top quartile of E&Ps over the next few years, we remain concerned regarding netbacks due to the company's much higher operating cost structure than peers. The company's lease operating expense, including gathering and transportation, averaged $1.68 per Mcfe in 2Q 2005, almost triple other companies. The company's price differential is also greater than peers due to greater fuel and shrink losses. We believe that within operating costs, there is room for about a $0.20 per Mcfe decrease when the pace of dewatering slows and a greater percentage of the company's operating wells are producing gas, but that costs will still remain high. Because of this, we believe that the Street may expect greater free cash flow from Western going forward than the company will deliver. Western does have lower finding and development costs than its peers (measured by DD&A rate) which partially offsets higher operating costs. Any signs of cost decreases could be a positive catalyst for the stock.
(3) Exploration. We believe the stock would respond positively to any positive exploration news and expect some announcements in the Pinedale Anticline, Niobrara, Uinta Basin and the company's 500,000 acre stealth play in the next six months. We are encouraged by the potential of the Pinedale deep test, being conducted by Questar Corp. (OP/A), in which Western has about a 10% interest. We believe that Ultra Petroleum (IL/A) and Questar are more exposed but that success would benefit all three stocks. In the Niobrara, Western and other players are trying to solve water saturation issues, while in the company's stealth play, Western expects to drill wells testing a shallow unconventional gas formation this fall. 2Q 2005
RESULTS MIXED
Western reported mixed 2Q 2005 operating and financial results, as generally strong E&P results were offset by weaker than expected midstream performance. Adjusted EPS of $0.49 was below our estimate of $0.53, and operating cash flow of $73 million was lower than our forecast of $83 million. E&P production of 167 MMcfe/d was slightly above our estimate of 163 MMcfe/d, and the company's average realized gas price was $4.61 per Mcf versus our estimate of $4.36 per Mcf. Costs rose quarter-over-quarter and were above our expectations, with lower than anticipated lifting costs (ex-gathering and transportation) of $5.52 per BOE more than offset by higher than expected royalties ($3.54 per BOE versus our estimate of $3.14) and DD&A ($6.67 per BOE versus our estimate of $6.40 per BOE). Gathering margins were slightly lower than 1Q 2005 despite a strong gathering quarter from part-partner Questar. We believe that Western is well positioned for throughput growth in the gathering business from both the Rockies and Mid-Continent, though the company will have to grow substantially in the second half to meet its 2005 guidance.
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. |
