E&Ps: Conoco acquisition of Burlington indicates rising confidence in strip prices, North American assets - Goldman Sachs - December 13, 2005
The announced acquisition of Burlington Resources (NR) by ConocoPhillips (NR) indicates increased confidence by at least one major integrated oil that North American natural gas prices will remain high for the next several years, a belief that is not implied by the valuations of gas- focused E&P equities. While above mid-cycle commodity prices is a fundamental tenet of our Attractive coverage view and super-spike outlook, merely using strip prices to calculate incremental free cash flow for gas- focused E&Ps yields 40% upside from current levels. We believe that this deal is attractive for all E&Ps -- those with less visible resource but high free cash yields such as Burlington (many of which trade at discounted valuations), and those that have growth and additional resource potential beyond proved reserves.
(Goldman Sachs & Co. and/or one of its affiliates is acting as financial advisor to ConocoPhillips in the proposed acquisition of Burlington Resources Inc. Goldman Sachs & Co., and or one of its affiliates will receive a fee for its financial advisory role.)
OUTLOOK RISING FOR NORTH AMERICAN NATURAL GAS PRICES AND ASSETS
The proposed Conoco-Burlington transaction represents the largest entry into onshore North American oil and gas in a couple of decades and is a stark reversal of asset shedding by many majors in North America to focus on international assets. We continue to believe that major integrated oils will look more closely at North American assets, both natural gas and heavy oil resource, for two key reasons.
* First, rising commodity price expectations, especially for North American natural gas. Gone are the days of major integrated oils' assuming long-term oil prices of $18-$22 per barrel and Henry Hub natural gas prices of $2.50-$3.00 per MMBtu. We think recent transactions assume natural gas strip prices for the next several years and 8% discount rates. Current forward NYMEX strip prices are at $12.05 per MMBtu for 2006, $10.15 per MMBtu for 2007 and $8.90 per MMBtu for 2008. We believe this is a significant statement that shows increased confidence that North American natural gas prices will remain high for the medium term.
* Second, it is increasingly difficult to acquire resource/acreage in key global "win zones." With much of the Middle East, former Soviet Union and Africa officially or unofficially shut to Western capital, major integrated oils have found that North American assets look increasingly attractive as long as there remains the balance sheet strength to be able to enter international regions should policies change and return-potential improve.
The combination of confidence in higher commodity prices and fewer resource addition options have turned US natural gas assets into at least a medium-term "win zone" in our view. We expect there could be additional consolidation as majors and non-North American-based regional oils look to enter/bolster positions in North America. Key themes remain unconventional natural gas, oil sands/heavy oil and the deepwater.
FUTURE CONSOLIDATION COULD FOCUS ON BOTH GROWTH AND FREE CASH ASSETS
We believe that the Conoco-Burlington transaction benefits all E&Ps, all market capitalization levels and all strategies. Among natural gas-focused E&Ps, we see two distinct categories of companies:
* Those with visible growth, usually from unconventional gas. Large cap visible growth companies (CHK, ECA, EOG and XTO) trade at a 2007E EV/DACF multiple of 5.2x, while mid- and small-cap visible growth E&Ps (STR, SWN, UPL, BBG, KWK and WGR) trade at 8.4x.
* Those with less visible growth that usually have a greater percent of assets from conventional sources or are more exploration focused but have higher free cash yields. Large-cap conventional E&Ps (APC, DVN, KMG and BR before deal speculation began) trade at an average 2007E EV/DACF multiple of 4.1x, while mid- and small-cap conventional E&Ps (NFX, NBL, PXD, PPP, BRY, COG, EAC, FST, THX) trade at 4.1x.
Burlington is in the conventional/less visible camp with strong returns and free cash flow. However, at $92 per share, Conoco is paying a multiple of 5.5x 2007E EV/DACF, which puts Burlington almost on par with growth companies. This transaction supports improved valuation for conventional E&Ps that have high free cash yields (NBL, DVN and APC in particular), but we continue to believe that visible growth E&Ps deserve premium valuation. In particular, we would note that XTO not only has superior growth (~10% organically) but also has superior returns and an above-average free cash yield (10%-11%) and trades at 5.3x 2007E EV/DACF. We believe that consolidation potential could extend to mid- and small-cap E&Ps as well. Among more oil-levered E&P-oriented stocks, we would highlight MUR, SU, CNQ and OXY among visible growth players.
NATURAL GAS PRICES HEAVILY DISCOUNTED IN EQUITY VALUATIONS
We continue to believe that even following the recent rally in gas-focused E&Ps, equity valuations reflect unwarranted conservatism regarding 2006 natural gas prices. The NYMEX forward strip prices for 2006 of $12.05 per MMBtu are above our $10.00 per MMBtu estimate and dramatically above the $8.50 per MMBtu we believe is reflected in consensus E&P estimates (at $10 per MMBtu, our 2006 EPS estimates are about 20% above consensus for gas-focused E&Ps). We see 20% upside to traditional peak values for E&P-oriented stocks, which are based on 1990s peak multiples. However, the Conoco-Burlington acquisition raises the bar beyond traditional peak multiples in its assumption of strip prices through 2008. Assuming incremental free cash flow from strip prices (natural gas of $12.05, $10.15 and $8.90 per MMBtu and oil of $63.50, $64.30 and $62.70 per barrel for 2006, 2007 and 2008, respectively), we see 40% upside for gas-focused E&Ps. Our top picks remain XTO, NFX, SWN, BBG and ECA among gas-focused E&Ps and SU, CNQ and MUR among oil-focused E&Ps.
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. 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.
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.
Pricing as of 12/12/05: Berry Petroleum (IL/A, $62.71), Bill Barrett Corp. (OP/A, $40.43), Burlington Resources Inc. (NR, $82.50), Cabot Oil & Gas Corp. (IL/A, $45.95), Canadian Natural Resources Ltd. (OP/A, $50.85), Chesapeake Energy Corp. (IL/A, $32.47), ConocoPhillips (NR, $61.25), EnCana Corp. (OP/A, $51.24), Encore Acquisition Company (IL/A, $34.41), EOG Resources Inc. (IL/A, $78.80), Forest Oil Corp. (IL/A, $48.50), The Houston Exploration Co. (IL/A, $55.43), Murphy Oil Corp. (OP/A, $55.23), Newfield Exploration (OP/A, $51.73), Noble Energy (IL/A, $42.75), Pioneer Natural Resources Co. (IL/A, $53.64), Pogo Producing Company (IL/A, $52.47), Questar Corp. (IL/A, $79.47), Quicksilver Resources, Inc. (IL/A, $45.45), Southwestern Energy Co. (OP/A, $35.94), Suncor Energy Inc. (OP/A, $64.25), Ultra Petroleum (IL/A, $58.60), Western Gas Resources, Inc. (U/A, $51.13) and XTO Energy Inc. (OP/A, $45.59) |
