Gas E&Ps favored with winter looming - Launching on CHK and SWN, downgrading STR. - Goldman Sachs - October 24, 2005
We prefer E&P stocks more exposed to natural gas and believe equity valuations are already assuming a warm US winter following the recent pullback. We are now assuming $10 per MMBtu for 2006 Henry Hub natural gas prices, and we slightly favor growth companies in East Texas and the Mid- Continent versus the Rockies. We are initiating coverage of Chesapeake Energy with an In-Line rating and Southwestern Energy with an Outperform rating while we are downgrading Questar to In-Line. Our top picks are XTO, NFX, BBG, SWN, and ECA, and our coverage view remains Attractive.
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.
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NATURAL GAS PRICES COULD REMAIN HIGH INTO 2006
We believe that natural gas prices could remain high into 2006 and could further spike in the event of a cold winter. While natural gas prices have, for the last two years, been a follower of crude and refined product prices, a natural gas inventory crisis could cause natural gas prices to lead refining margins higher. We now estimate Henry Hub gas prices of $10 per MMBtu for 2006 and believe that a warm winter is priced into oil and gas equity valuations.
THE ROCKIES REMAINS A MAJOR SOURCE OF EXPECTED GROWTH ...
We continue to believe that the Rockies will show superior growth and returns over the medium to longer term. However, we have lowered our rating on Questar to In-Line from Outperform, reflecting strong price performance and more limited near-term exposure to natural gas prices. We continue to recommend EnCana and Bill Barrett Corp. because of exposure to the Piceance Basin where we see multiple catalysts in the next six months.
... BUT OTHER GROWTH REGIONS HAVE IMPROVING NEAR-TERM CASH FLOW EXPOSURE
East Texas and the Mid-Continent should show a greater combination of production growth and natural gas price exposure vs. the Rockies in our view. While Mid-Continent differentials could widen, we nevertheless see a greater widening in the Rockies. We initiated coverage of two Mid-Continent producers - Southwestern Energy with an Outperform rating and Chesapeake Energy with an In-Line rating. Our top pick remains XTO Energy
WE SEE ATTRACTIVE VALUATION FOR BOTH UNCONVENTIONAL AND CONVENTIONAL E&Ps
While many conventional E&Ps lack the visibility of production growth relative to unconventional gas E&Ps, we nevertheless see valuation improving for many conventional E&Ps. Newfield is our top pick among conventional E&Ps, while Cabot Oil and Gas is our top In-Line rated stock.
WE ARE INITIATING COVERAGE OF CHESAPEAKE WITH AN IN-LINE RATING
We believe that Chesapeake has the most upside to increased commercially recoverable resource from higher natural gas prices relative to its peers. Given the recent pullback in oil and gas equities, we believe shares of Chesapeake are attractive. Our In-Line rating is a function of more attractive opportunities at other visible large-cap growth E&P stocks at present, in part due to Chesapeake's peer-average cash-on-cash returns. At 4.4x 2006 EV/DACF, valuation is attractive versus other visible growth peers, although mid-cycle valuation is at a premium to peers. We see 29% upside to a $38 traditional peak value.
WE ARE INITIATING COVERAGE OF SOUTHWESTERN ENERGY WITH AN OUTPERFORM RATING
We see further upside from developments in the Fayetteville Shale, an area where we expect consolidation over the coming years. We believe Southwestern's management has been very conservative in its portrayal of the Fayetteville and that the company for now has the best position relative to its peers. Southwestern has attractive collar hedges that should still allow it to benefit from higher-than-expected winter natural gas prices. At 9.5x 2006 E&P, Southwestern trades at similar levels with Questar and other mid- and small-cap visible growth peers. We see 34% upside to a $86 traditional peak value.
WE ARE DOWNGRADING QUESTAR CORP. TO IN-LINE FROM OUTPERFORM
We believe that the company is now trading closer to parity relative to estimated mid-cycle and peak values for other E&P companies, which had been one of the key reasons for our recommendation. While we continue to believe the Pinedale Anticline will generate superior growth and returns, we believe that for Questar there are few key catalysts on the horizon, and the company has hedged a higher-than-average portion of winter 2005-06 natural gas production at fixed prices. We do not expect to get a clear view of deep Pinedale potential until mid-2006 at the earliest. Ultra Petroleum remains the most exposed among Pinedale players, although it continues to trade at steep premiums to estimated net asset value.
UPDATED ESTIMATES
We have updated our estimates for E&Ps, domestic oils and integrated oils to reflect a $10 per MMBtu Henry Hub natural gas price for 2006 versus $9 per MMBtu previously and an $11 per MMBtu price for 4Q 2005 versus $9 previously. New estimates for Forest Oil reflect the expected splitoff of the company's Gulf of Mexico assets. New estimates for EnCana include the announced sale of its assets in Ecuador. New estimates for Pioneer Natural Resources include expected natural gas production from South Africa. New estimates for The Houston Exploration include the recently-announced development disappointments. New estimates for Talisman Energy include the recently-announced acquisition of Paladin Resources. In addition, we have adjusted 3Q 2005 and 4Q 2005 earnings estimates for expected hurricane-related impacts and have made other minor company adjustments. A summary of our EPS revisions is in the enclosed exhibit.
Goldman Sachs & Co., and or one of its affiliates, is acting as advisor to Talisman Energy Inc. in the proposed offer for Paladin Resources PLC, and as such is an associate of Talisman Energy Inc. for the purpose of the Takeover Code. Goldman Sachs & Co., and or one of its affiliates, will receive a fee for this advisory role.
Goldman Sachs & Co., and or one of its affiliates, is acting as financial advisor to Occidental Petroleum Corporation in the proposed acquisition of Vintage Petroleum Inc. Goldman Sachs & Co., and or one of its affiliates, will receive a fee for its financial advisor role.
Goldman Sachs & Co., and or one of its affiliates, is acting as advisor to Pogo Producing Company in the proposed sale and or partial sale of one of their division or operating units. Goldman Sachs & Co., and or one of its affiliates, will receive a fee for this advisory role.
Goldman Sachs & Co., and or one of its affiliates, is acting as financial advisor to Pogo Producing Company, Inc. in the proposed acquisition of Northrock Resources from Unocal Corporation. Goldman Sachs & Co., and or one of its affiliates, will receive a fee for its financial advisor role.
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. |
