Occidental Petroleum (OP/A): Analyst meeting preview--Enhancing confidence in the enhanced oil recovery strategy - Goldman Sachs - February 14, 2006
We believe Occidental Petroleum's February 23 analyst meeting will showcase the company's 2006-2010 outlook and raise investor confidence in the company's ability to grow E&P production at least at a mid-single digit per annum growth rate while maintaining top-quartile ROCE. In our view, Oxy's competitive advantage comes from its focus on enhanced oil recovery strategies which help stem production declines and allow growth projects to be truly incremental. With Oxy currently trading a discount to its peers, coupled with the recent pullback in the energy sector, we believe its shares are at an attractive entry point. We see 27% upside to our $110 "traditional" peak value relative to the peer group on average showing 26% upside. We note that Oxy currently trades below our mid-cycle valuations which reflect a $35 per barrel long-term WTI oil. Oxy remains one of our top picks and OP/A rated.
For additional details on our view on Occidental Petroleum, please see our report published on May 26, 2005, "Upgraded to OP given reloading of its E&P portfolio" Message 21360559 , our note published on October 14, 2005, "Oxy to acquire Vintage Petroleum" Message 21794600 , our note published on November 1, 2005, "E&P portfolio positioned to resume multi-year growth at industry-leading ROCE" Message 21844140 , and our note published on January 30, 2006, "E&P portfolio reloaded, relative valuation inexpensive, reinstating view with OP/A rating following a period of Not Rated" Message 22118708 .
OXY ON-TRACK TO RESUME 5%+ E&P PRODUCTION CAGR
With 2005 largely a transition year for Oxy in which the company re-loaded its E&P portfolio, we believe Oxy now appears on-track to deliver at least a 5% CAGR over the next five years. We estimate Oxy's E&P production could reach roughly 790,000 BOE/d by 2010 from a base of 645,000 BOE/d which includes Vintage assets adjusted for projected asset sales. Projects in the Middle East account for roughly 60% of the growth, which is largely distributed evenly between projects in Oman, Qatar, and Libya. Opportunities in the US and Argentina account for the remaining growth (see Exhibit 1). Assuming a base of 596,000 BOE/d, Oxy's year-end exit rate which excludes Vintage production, we estimate E&P production to grow at a 6% CAGR through 2010.
We believe a 5%-6% CAGR could ultimately prove conservative as potential additional EOR Middle East projects, CO2 injection at its large Elk Hills field in California, and exploration success in Libya could incrementally add to Oxy's production profile. In our view, helping Oxy's ability to deliver an above peer group average growth rate is its long-lived asset base and low-risk EOR based projects. Its long reserve life both on proved developed (PD) and overall reserves basis stems production decline rates and allows for E&P projects to be truly incremental to growth. This is in contrast to some of its domestic oil/E&P peer group where large E&P projects often merely offset steep decline rates.
Oxy's most recent development in potentially sequestering CO2 with BP in California we believe is an example of the extent of the company's potential ultimate recoverable reserves and ability to extend the asset life of mature fields. While it is sometimes easier to get excited about exploration success and unconventional resources as it relates to a company's resource base, we believe investors should not easily dismiss EOR opportunities especially for a company such as Oxy which has had a strong track-record in such strategies. It is our understanding that a successful application of CO2 flooding could raise the ultimate recoverable resource in California by potentially as much as 1 billion BOE over the long run.
OXY LIKELY TO MAINTAIN ABSOLUTE AND RISK-ADJUSTED ROCE ADVANTAGE
We believe Oxy's ROCE advantage over its peer group should continue over the next several years, driven primarily by Oxy's lower capital intensity given its long-lived asset base, management's capital discipline, and focus on EOR-type projects. In our view, investor concerns over large government takes in the Middle East are over-done. Oxy has shown that in recent years ($26-$40 per barrel WTI oil in 2001-2004), it was able to generate top-quartile ROCE (27% on average versus the peer group average of 13%) and industry-leading profit per barrel ($13 per BOE versus the peer group average of $7) from its Middle East assets. Management has expressed confidence that it expects future projects in the Middle East to generate similar returns to those of its legacy assets. Further, although detailed regional break-down for 2005 results will not be available until the company's 2005 10-K is filed, Oxy's overall performance is likely a good indicator that it continues to achieve top-quartile results in the Middle East despite $55+ per barrel WTI oil in 2005. We estimate Oxy's 2005 ROCE and its E&P profit per barrel to have been 25% and $19 per BOE, versus the peer group average of 20% and $14 per BOE, respectively. Specifically to the Middle East, we estimate 2005 ROCE of roughly 30% and profit per barrel of $22 per BOE.
INVESTOR CONCERNS OF HIGH POLITICAL RISK MISPLACED
In our view, Oxy is not over-exposed to the Middle East, Latin America, or any one country. Oxy's track-record has shown that in the countries it has operated--namely Libya, Oman, Qatar, UAE, Yemen, Argentina, and even Ecuador--have honored contracts signed with Oxy to date. Although future political turmoil is by nature unpredictable, the likelihood that production is affected in a meaningful amount, i.e., in multiple countries it operates in all at the same time, is small. Further, even if such disruptions were to occur, we believe the consequent rise in world oil prices to the benefit of Oxy's remaining 60%-80% of its production would overwhelmingly offset output loss. As such, we continue to view Oxy's positioning in the Middle East and Latin America as a competitive advantage and that the positives of a large, attractive resource base of current and future opportunities outweigh perceived negatives of geopolitical risk.
$60+ LONG-DATED WTI OIL LIKELY BENEFITS OXY DISPROPORTIONATELY
Given its long-lived asset base, we believe Oxy would benefit disproportionately from investors ratcheting up long-term WTI oil price expectations. Oxy's PD R/P of more than 10 years and overall R/P of nearly 13 years--versus the peer group average of 8 and 12 years, respectively--increases the relative relevancy of long-dated oil prices to its future cash flow. If investors can gain confidence in the sustainability of high commodity prices, which we believe could occur in 2006, Oxy shares could outperform.
USE OF FREE CASH FLOW A KEY QUESTION FOR ANALYST MEETING
Although historically Oxy has shunned share buybacks, we believe an announcement of a buyback program beyond the already announced 9 million share repurchase related to its acquisition of Vintage could spark a rally in the shares. In our view, Oxy has the balance sheet flexibility and robust free cash flow to commit to a share buyback program. We estimate Oxy's free cash yield excluding acquisitions to be 13% for both 2006E and 2007E despite Oxy's peak CAPEX year likely being in 2006 at slightly lower than $3.4 billion. In terms of its balance sheet, Oxy at year-end 2005 had nearly as much cash as debt and, including the Vintage acquisition, we estimate Oxy will end 2006 with more cash than debt. Finally, we estimate that Oxy net debt-to-tangible capital at year-end 2007E would still be less than 10% even if Oxy engages in another bolt-on acquisition ($5 billion or less), executes a $4.5 billion cumulative share repurchase program, and spends over $6 billion in CAPEX through 2007. Note, we assume $68 per barrel WTI oil and commensurate other commodity prices for 2006E and 2007E.
VALUATION: 27% UPSIDE TO A $110 "TRADITIONAL" PEAK VALUE VERSUS 5%-10% DOWNSIDE TRADING RISK
We see 27% upside to a $110 "traditional" peak value and 66% upside to a $143 super-spike adjusted peak value. This compares to the respective peer group average upside of 26% and 62%. With the energy sector having recently pulled back around 15% (11% for Oxy), we believe downside trading risk is limited to 5%-10%. With Oxy trading 4% below our $90 "traditional" mid-cycle, which reflects a conservative $35 per barrel long-term WTI oil price, we believe its shares are at an attractive entry point.
On EV/DACF (enterprise value to debt-adjusted cash flow), we estimate Oxy shares currently trade at 4.5X 2006E and 4.4X 2007E relative to its domestic oil/E&P peer group average of 5.2X and 4.6X, respectively. In our view, as investors gain confidence in Oxy's attractive combination of growth and returns, we believe its shares could trade towards a premium. See Exhibit 2 for comparative risk/reward and valuation. See Exhibit 3 for a summary model of Oxy.
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, Luis Ahn. |
