Berry Petroleum (IL/A): Solid execution on producing assets; potential upside from Diatomite, Rockies exploration - Goldman Sachs - November 03, 2005
We believe Berry Petroleum is showing strong progress in developing its producing properties in California and the Rockies. We are currently forecasting about 9% year-over-year production growth for 2006--roughly in line with company guidance--but believe there may be upside to this estimate. At 5.9x 2006E EV/DACF, Berry trades at a premium to the small-cap E&P average of 4.9x, which we view as justified given Berry's high returns, long-lived asset base, and growth prospects. Still, we believe meaningful upside in Berry's shares relative to its peers would require sanctioning of the company's California Diatomite project and/or material exploration success in the Rockies. News flow from these areas is expected over the next several months, and will in our view be a key catalyst of Berry's share performance. We rate Berry In-Line relative to an Attractive coverage view.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Potential sanctioning of the Diatomite project in California. Berry continues to move along with its 25 well pilot drilling program in the Diatomite formation in the northern area of the Midway-Sunset field. The company has thus far drilled 13 wells, and has seen some positive signs in terms of reducing the steam-oil ratio (SOR) down to acceptable levels. Assuming a West Texas Intermediate (WTI) spot oil price in the mid-to-high $40s (the lower end of the collar with which Berry has hedged about 10 Mb/d of its 2006-2009 oil production), we believe an SOR of 7-to-1 or below would be necessary for the project to yield "cost-of-capital"-level returns, with an SOR lower than 7-to-1 (or a higher oil price) providing additional upside. On today's conference call, CEO Bob Heinemann indicated that SORs as low as 5- or 6-to-1 had been realized, though he cautioned that it remains unclear whether this can be accomplished sustainably and consistently. The drilling program will continue throughout 4Q 2005, and we believe further results and a decision on project sanctioning (or abandonment) could occur in the second half of 2006.
(2) Drilling results from Rockies exploration prospects. Along with partner Bill Barrett Corp. (OP/A), Berry continues to explore high-risk/high-reward prospects in the Rockies, success in any one of which could add material production and reserves to the company. Notable among these prospects is Lake Canyon, where Berry is seeking shallow oil in the Green River formation analogous to its current Brundage Canyon production. The company plans to spud two oil wells here by the end of November. Also at Lake Canyon, Berry has a 25% non-operated working interest in Bill Barrett's deep gas wells, one of which is currently being drilled and will likely be completed in the next month or so. In addition, Berry has begun drilling its 10 well coal-bed methane (CBM) pilot program in the Coyote Flats joint venture with Petro-Canada (U/A), though we do not expect results until 1Q 2006 at the earliest. Finally, the company continues to acquire seismic data on its large acreage position in the Tri-State prospect, adjacent to its producing Niobrara gas field. As an aside, we do not believe the recently announced retirement of Mr. Bill Barrett, CEO of Berry's key Rockies partner Bill Barrett Corp., will alter the companies' drilling plans or co-operation in the Rockies. Even while Bill Barrett Corp. is undergoing a formal search for a replacement CEO (including both internal and external candidates), we believe the strong ties between Berry and Bill Barrett Corp. throughout the management ranks will allow their Rockies ventures to continue to flourish.
(3) Continued execution on producing properties. To this point, Berry has been successful in ramping up production from Brundage Canyon and Niobrara gas fields, and we believe the company is well on track to meeting its guidance of 23,000 BOE/d of total company production for 2005. Given that Berry is still a relatively new entrant into the Rockies and that most of its exploration opportunities are adjacent and geographically similar to its producing properties, it is particularly important for the company to continue showing consistent positive operating results for its broader program to gain credibility. In California, where Berry is an established operator, the most important near-to-medium term catalyst will be the company's ability to lock in a favorable light-heavy differential for its crude. Berry's contract with Shell Oil for a substantially below-market $6/bbl differential versus WTI is set to terminate at the end of this year, and the company is currently seeking a new contract. Given our bullish outlook for commodity prices, we would view it favorable if Berry can lock in a differential below $10/bbl for the next several years.
3Q 2005 RESULTS GENERALLY IN LINE WITH EXPECTATIONS
Berry reported 3Q 2005 operating and financial results generally in line with our expectations. EPS of $1.52 was above our $1.36 estimate, while operating cash flow of $52 million and production of 23,600 BOE/d was in line with our estimates of $52 million and 23,100 BOE/d, respectively. Berry's realized oil price of $44.84 per barrel was in line with our estimate of $45.23 per barrel, while the company realized a better than expected gas price of $7.18 per Mcf (vs. our estimate of $6.62 per Mcf). Net debt/tangible capital was 24% at quarter-end. UPDATING ESTIMATES We are adjusting our 4Q 2005 EPS estimate mainly to incorporate higher assumed operating costs due to higher natural gas prices. We now estimate 4Q 2005 EPS of $1.50 vs. $1.58 previously. Our 2005 full-year EPS estimate is now $5.20 ($5.12 previously), as the positive 3Q variance was only partially offset by the lowered 4Q estimate. There are no changes to our 2006-2010 EPS estimates. Exhibit 1 shows our summary model for Berry.
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. 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: Arjun Murti, Brian Singer. |
