Ultra Petroleum (IL/A): Pinedale growth on track, though other E&Ps more attractive - Goldman Sachs - February 09, 2006
We continue to believe that the Pinedale Anticline, one of North America's most prolific gas basins, will drive growth, returns and low finding and development costs for Ultra Petroleum (IL/A). We expect Pinedale production to rise 32% in 2006 and 20% annually from 2006 through 2010. Our expectation for full 10-acre downspacing at Pinedale, the potential for further downspacing, and success in commercially recovering resource in deeper Pinedale formations could both extend drilling inventory and raise medium-term growth. Additional catalysts include results from the company's exploration well in Appalachia and potential for year-round completion activity at Pinedale. Despite our bullishness on Pinedale, we see more upside for other E&Ps and for other Pinedale players due to UPL's strong "pure-play" premium valuation. Our OP/A-rated unconventional gas stocks include XTO, SWN and BBG.
(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.)
Key near-term catalysts
(1) Down-spacing, deep test well should add meaningful reserves. We believe that Ultra will begin to share results from its five 10-acre operated pilots with the Wyoming Oil and Gas Conservation Commission toward mid-year 2006 with the ultimate goal of getting approval for full 10-acre spacing. We believe Ultra shares are assuming full 10-acre spacing already, however. Management sees increasing potential for testing 5-acre pilots similar to activity at the neighboring Jonah field, and we do not believe there is much value being afforded Ultra shares for 5-acre potential. A greater catalyst than 5-acre spacing for 2006 is results from two deep Pinedale exploration wells being drilled by Ultra (3Q06 spud) and Questar Corp. (2Q05 completion). Pinedale development wells currently drill to the Lance Pool (Lance and Mesaverde formations), and the deep wells will test the Hilliard and Rock Springs formations. Success in these wells would be another positive for both Ultra and Questar (we have estimated it could represent $12 per share for both Ultra and Questar) because we believe the companies and the Street will assume virtually homogeneous geologic formations across the Anticline.
(2) Accelerated drilling/completion key to multiples expansion. We are assuming total company production growth in 2006 and 2007 of 29% and 35%, respectively, versus the company's expectation of about 33% and 19%, respectively. This should lead to meaningful free cash flow (beyond the company's announced $425 million capital expenditures budget, of which $395 million comes from Pinedale), and we believe Ultra will look for opportunities to accelerate drilling, acquire other Pinedale players' interests and buyback stock (in that order). Regulatory and infrastructure issues have been the primary constraints to accelerating drilling at Pinedale, though we believe both Ultra and Questar have both been successful in optimizing drilling and completions to increase overall completed wells. With year-round drilling now having been approved for much of Pinedale, the key seasonal constraint is prohibitions on year-round completions. Authorities approved limited winter well completions in the Pinedale this season, and we believe Pinedale operators will ask for additional year-round completion approval for next year. A key catalyst is likely to be whether there were any changes in animal migratory patterns from these completions. Drilling acceleration is a key variable in increasing present value of Ultra's vast Pinedale resource base.
(3) Development of Bohai Bay fields underway with additional exploratory potential. Of the nine discovered fields in the 04/36 and 05/36 blocks in Bohai Bay, four are currently producing. Ultra plans to drill 2 exploratory wells in China and start production at three more fields (the 11-6, 12-1, and 12-1 south fields) in 2006. We assume China production growth of 7% to 4.3 Mb/d from 4.1 Mb/d.
Valuation
We believe that Ultra deserves to trade at a premium valuation to its peers, on account of its significant exposure to the Pinedale, one of the top natural gas assets to hold in North America. We believe that discounted cash flow net asset value analysis is the preferred way to value Ultra's resource potential, rather than reserve-based approaches that do not take into account the timing of production. Within a DCF framework, however, we believe that Ultra should be valued at a lower discount rate versus its peers, mainly because we have more confidence that free cash flow will be deployed into the Pinedale, toward Pinedale acquisitions or to shareholders in the form of dividends or stock buybacks. Nevertheless, even assuming a discount rate advantage, we believe Ultra shares are already including some credit for deep Pinedale potential or further drilling acceleration versus Pinedale peers, and we believe Ultra shares at $64 are at our revised traditional peak value ($50 previously), which do not include value for 5-acre spacing or deep success. Ultra shares trade at 19.0x 2006 EV/debt-adjusted cash flow.
Reported EPS above our and consensus estimates
Ultra reported 4Q 2005 EPS of $0.52, higher than our estimates of $0.46 and consensus estimate of $0.47. Production was in line at 232.0 MMcfe/d versus our estimate of 234.4 MMcfe/d. Realized U.S gas prices were $8.49 per Mcf, higher than our estimate of $7.76 per Mcf. Total costs were generally in-line at $2.39 per Mcfe versus our $2.31 per Mcfe, with lower-than-expected SG&A costs offset by higher-than-expected production taxes and DD&A.
Updated estimates
We are introducing quarterly estimates for 2006, as well as updating our full-year 2006 EPS estimate and lowering our gas price assumption in 2006 to $9.50 from $10.00. Our estimates reflects slightly lower production and minor other company adjustments. Our new 1Q, 2Q, 3Q, 4Q estimates for 2006 are $0.40, $0.35, $0.47, and $0.67, respectively. Our updated full-year 2006 estimate is $1.88 ($1.96 previously). There are no changes to our 2007 and 2008-2010 (normalized) EPS estimates. Exhibit 1 shows our summary financial model for Ultra.
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. |
