Pioneer Natural Resources (IL/A): Drilling results from more exploratory onshore plays key to medium-term performance - Goldman Sachs - February 09, 2006
We believe that Pioneer Natural Resources' March 9 analyst meeting will highlight the company's emerging North American exploration and development opportunities and its capital allocation to drilling/acquisitions versus share repurchase/dividends. We believe Pioneer (IL/A) needs success in South Texas and/or the Rockies to add meaningful reserves via the drillbit, and if these ventures are unsuccessful the company will likely need to make further acquisitions to add proved reserves. Pioneer's 2005 drillbit reserve replacement was just 1%, and because much of the company's 2006 drilling will be focused on proved undeveloped locations, we believe the company may have a below-average drillbit reserve replacement rate in 2006. While we expect double-digit production growth, Pioneer's valuation already trades at a premium valuation to other E&Ps, and we see greater upside for other stocks. KEY
COMPANY-SPECIFIC CATALYSTS
(1) Production ramp-up from legacy assets. As Pioneer's focus turns to its legacy assets, the company has increased its rig count in the Spraberry field to 10 rigs (slightly below earlier company estimates) with a goal of about 18 rigs by August. In the Gulf Coast, Pioneer will continue to drill at its legacy Pawnee field. And while results in Colorado's Raton Basin has been much worse than expected to date, the company has remaining inventory that can grow Raton at an estimated 6%-7% per year. Pioneer has for some time shown a much greater reserve life than its peers, and we believe the focus of drilling in 2006 will be on the company's proved undeveloped locations. While the company has remaining probable locations in Spraberry and Raton, the bulk of additional inventory is already booked as proved undeveloped, and we believe that this could constrain somewhat 2006 reserve replacement and increase finding and development costs.
(2) Large development projects outside onshore North America. While 2006 reserve replacement may be weak, the company has unbooked resource from Alaska and South Africa that could help reserve replacement and finding development costs in 2007-10. In Alaska, we believe 49 million barrels are likely to be booked in increments between 2008-11, with net production ramping up to a peak rate of 12,000-13,000 bpd of crude during that period. We believe the Street may remain skeptical on the success of Alaska until closer to startup date, given small- and mid-size independent producers' more limited experimentation and success with Alaska in the past. In South Africa, we expect the company to add 45 MMcf/d in natural gas production beginning in 2007, though unlike Alaska, about 60%-70% of estimated resource in South Africa is already booked as proved reserves. Regardless, the combination of the reserve life-decreasing growth from Spraberry, Pawnee and Raton with Alaska and South Africa gives Pioneer relatively visible production growth through the end of the decade.
(3) Exploration for longer-term visible growth resource in South Texas and the Rockies. While Pioneer's development drilling in the Raton Basin has underperformed, the company has built exploratory acreage positions which, if successful, could hold longer-term 1+ Tcf drilling opportunities. The company plans to provide greater detail on its Columbine Springs coal-bed methane (CBM) play in the Piceance Basin, the Lake Creek CBM play in the Sand Wash Basin and the Castlegate CBM play in the Uinta Basin. Additionally, the company expects to drill 200 wells in the Horseshoe Canyon CBM play in Canada with exploratory potential from the Mannville coals (4 horizontal wells are expected to be drilled in 2006). We believe it is essential for these projects to be successful to boost Street confidence in Pioneer management's drillbit expertise. From a production growth perspective, because CBM wells are smaller in size, it may take until 2008 for new Rockies projects to have a material impact on total company production growth. The more conventional Edwards play in South Texas could have a greater near-term production impact, and the company plans to drill 20-30 exploration/development wells this year (the first is awaiting completion).
(4) Company could further increase share repurchase, pursue bolt-on acquisitions. While the company delayed its analyst meeting until March 9 to add some flexibility for delays in the announcement of its expected Gulf of Mexico asset sale, we would not be surprised if the company announced results closer to its original February 22 date (though it remains to be seen if the recent Clipper deepwater success is included in the sale). Of the $675 million from the sale of the company's Argentina assets and the $800 million in estimated proceeds from the Gulf of Mexico assets, we believe the company may use more than its pledged $350 million towards the second phase of share buybacks. We believe Pioneer will likely use the additional proceeds to reduce debt and maintain a capital spending program similar to that of 2005 (we currently assume 2006 capex of $1.2 billion). Additionally, we believe that the company will continue to look to acquire additional acreage in Spraberry and South Texas.
VALUATION
Pioneer exhibits reserve life characteristics of unconventional companies (an estimated 21-year reserve life for 2006-08 vs. large- and mid-cap unconventional E&Ps that have an estimated 14-year R/P), though with inferior cash-on-cash returns and return on capital employed. For unconventional gas companies, we have greater confidence in unbooked resource potential than we do for Pioneer until the company demonstrates additional success from its emerging exploratory plays. Pioneer's 2006 EV/debt-adjusted cash flow of 6.2x is well above the large- and mid-cap conventional E&P average of 4.7x. However, unless the analyst meeting can instill confidence in the potential to add future reserves from the Rockies and Texas, Pioneer's multiples may be viewed as too high and could contract closer to those of conventional-E&Ps.
ADJUSTED EPS BELOW CONSENSUS ESTIMATES
Pioneer reported 4Q 2005 adjusted EPS of $0.74, in line with our estimate but lower than First Call consensus estimate of $0.97. Operationally, Pioneer fared well although larger-than-expected taxes of $94 mln versus our $55 mln reduced operating income (although most of it was non-cash deferred taxes). Operating cash flow was $412 million versus our $334 million estimate. Total production when adding production from volumetric production payments was higher than expected at 1.07 Bcf/d versus our 1.05 Bcf/d estimate, while realized US natural gas prices were also higher than expected at $7.57 per Mcf versus our $6.82 per Mcf. All-in costs were in-line. Pioneer's net debt/tangible capital is now 52% versus 51% last quarter.
UPDATED ESTIMATES
We are introducing quarterly estimates for 2006, as well as updating our full-year 2006, 2007, and 2008-2010 (normalized) estimates and lowering our gas price assumption in 2006 to $9.50 from $10.00. Our estimates reflect the impact of the Gulf of Mexico/Argentina asset sales and lower DD&A. Our new 1Q, 2Q, 3Q, 4Q estimates for 2006 are $1.39, $0.89, $0.97, and $1.23, respectively. Our updated full-year 2006 and 2007 estimates are $4.48 ($4.05 previously) and $4.90 ($4.84 previously) respectively. Our 2008-2010 (normalized) estimates are $1.61 ($1.49 previously), $2.07 ($1.82 previously), and $2.46 ($2.05 previously) respectively. Exhibit 1 shows our summary financial model for Pioneer.
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. |
