XTO (OP/A): Trifecta of growth, returns and free cash flow; report published - Goldman Sachs - February 01, 2006
XTO Energy continues to be a top pick due to our belief that the company will continue to be a low-cost driller and will make acquisitions that will both manage the company?s decline rate and generate attractive further drilling opportunities. We have increased our expectations for drilling inventory, and we believe the company can maintain its returns advantage. Among large-cap E&Ps, XTO is unique in having superior production growth, superior cash-on-cash returns and superior free cash flow. We see 28% upside to a $63 traditional peak value and 50% upside to a $74 super-spike adjusted peak value.
Please see our detailed 24-page report, "Trifecta of growth, returns, and free cash flow." If you are on our e-mail distribution list, a .pdf is attached below.
Greater low-risk inventory than expected. We have raised our expectation for proved and probable reserves to 11.3 Tcfe from 10.0 Tcfe, both of which exclude potential from the Piceance Basin. Management is estimating 11.7 Tcfe in proved + low-risk probable reserves, so we believe our bottoms-up estimates is conservative. The bulk of additional inventory has come from the company's core East Texas assets, emerging development opportunities in the Uinta and San Juan Basin, and oil exploitation opportunities from assets acquired from majors in the Permian Basin.
Organic growth/decline rate balance remains superior. We believe the company is on track to grow production organically at double-digit rates in 2006 and has the capacity to grow at 10% in 2007. Management indicated it is not solely focused on production growth - acquisitions may be more attractive if commodity prices crash and share repurchase may be more attractive if commodity prices spike. While this could create controversy, we nevertheless believe that XTO will grow at a higher sustainable rate than other large-cap E&Ps. This greater sustainability comes from the company's lower decline rate than other large-cap growth E&P peers. This lower decline rate makes XTO's cash flows more visible and should lead to a lower discount rate.
Returns expected to remain high as XTO is the low-cost producer. With finding and development (F&D) costs of about $1.10 per Mcfe via the drillbit in 2005, we believe XTO will prove to be among the lowest-cost drillers, especially when adjusting for changes in the level of proved undeveloped reserves. This low drillbit F&D cost underlies XTO's returns advantage versus its peers. Our bottoms-up analysis suggests 2006 finding and development cost of about $1.40 per Mcfe, below our previous $1.50 estimate and consistent with the ability to show superior returns versus other E&Ps.
We view spinoff of Hugoton Royalty Trust positively. We believe management's decision to spinoff to shareholders the company's stake in the Hugoton Royalty Trust (HGT, not covered) is positive for XTO shareholders. The deal will reduce reserves and production for XTO, but gives shareholders a one-time dividend of about $2.25 per XTO share and a tax-efficient distribution that at 2005 levels would increase the implied dividend yield on XTO stock by 0.35% to 0.9%.
Valuation at peer average on EV/DACF, while EV/GCI premium has room to expand. XTO has traded at a premium to other E&Ps historically on both an EV/debt-adjusted cash flow basis and an EV/gross cash invested basis. More recently, the company's EV/DACF premium as fallen, and XTO currently trades at 6.0x 2006 EV/DACF, in-line with the E&P average and below the 6.8x for EOG Resources and 6.3x for EnCana Corp. On an EV/GCI basis, XTO's premium has stayed relatively flat over the last six months while its cash return on cash invested (CROCI) premium has increased. We believe that a greater premium could be justified consistent with XTO's greater relative returns.
We see 28% upside to a $63 traditional peak value and 50% upside to a $74 super-spike adjusted peak value. We estimate a traditional peak value for XTO's proved and low-risk probable resource base of $56 per share, based on our bottoms-up net asset value analysis. Our $63 per share traditional peak value assumes $7 per share from the Piceance Basin. While this does represent a higher-risk exploration opportunity, Piceance potential of 2.4 Tcfe represents just 28% of company-identified 8.5 Tcfe of resource upside above and beyond low-risk probable reserves. Given our belief in the Piceance Basin as a whole, we believe this credit is appropriate as it represents a reasonable success rate on the company's exploratory inventory.
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. |
