Berry Petroleum (IL/A): Numerous potential 2006 catalysts as drilling activity continues to ramp up - Goldman Sachs - February 22, 2006
We continue to believe Berry Petroleum is executing well in the early phases of diversifying its asset portfolio by acquiring and developing acreage in the Rockies. Recent developments--in particular the acquisition of properties in the Piceance Basin consisting mostly of probable and possible reserves--suggest increased aggression on Berry's part in pursuing Rockies growth. We believe 2006 will be a key year for Berry to further illustrate to investors its ability to operate successfully in the Rockies, with performance in the Piceance especially important. Also noteworthy will be news flow from Berry's pilot program in the Diatomite formation in California. We believe Berry's premium valuation is justified, but further multiple expansion and outperformance would require better than anticipated drilling results. We rate Berry In-Line relative to an Attractive coverage view.
KEY COMPANY-SPECIFIC CATALYSTS:
(1) Ramp up in production from Piceance acquisition. Progress in Berry's most recent Rockies acquisition will in our view be scrutinized closely by investors throughout 2006. Berry paid $5.77 per Mcf for proved reserves of 26 Bcf, with most of the $150 million purchase price considered to be paying for the probable and possible reserves of 304 Bcf. We believe it will be an important driver of share price performance whether Berry can rapidly ramp up production (currently estimated at about 1 MMcf/d) from the acquired acreage. On its 4Q 2005 earnings conference call, management indicated its intention to drill 30 wells (15 net to Berry) in 2006, with the possibility of more if Berry can contract additional rigs beyond the two it has already secured. For 2006, we are currently forecasting an exit rate of about 4.5 MMcf/d in the Piceance. For more detail on our view of Berry's Piceance acquisition, see our January 29, 2006 research note, "Piceance acquisition comes at a high price but with significant upside potential." Message 22112923
(2) Determination of Diatomite commerciality in mid-2006. Berry's most significant opportunity to add reserves in its traditional California heavy oil operations is its Diatomite program in the Midway-Sunset field, in our view. Indications from a 25 well pilot program continue to be positive, as production has now ramped up to 300 b/d. A final decision on the Diatomite's commerciality is expected in mid-2006 and a 50-well expanded drilling program is planned to begin in late 2006, assuming sanctioning of the project. We believe some level of success in the Diatomite will be necessary to keep Berry's base California production flat (or modestly growing) over the medium term.
(3) Other Rockies exploration and development. Berry has positive momentum in its Rockies program following favorable exploration results in the Green River Formation of Lake Canyon, near its producing Brundage Canyon acreage. After two successful wells announced in January, Berry will drill four additional wells and plans a 30-well program assuming results from the four wells are similar to (or better than) the two discovery wells. Among its other exploration acreage, Berry highlighted on its earnings conference call its Coyote Flats joint venture with Petro-Canada (PCZ; U/A), where it has drilled two offset wells to the original discovery well drilled in the Ferron sand by Prima Energy in 2002 and described the results as encouraging, without providing further detail. Berry is currently arranging pipeline access for Coyote Flats production, which suggests bullishness. We do not believe investors are discounting meaningful success at Coyote Flats, leaving room for upside if Berry can deliver any significant production or reserves from this prospect.
PREMIUM VALUATION DESERVED, BUT OUTPERFORMANCE WOULD REQUIRE BETTER THAN EXPECTED DRILLING RESULTS
Up a sector-leading 27.5% year-to-date, Berry's shares have performed well recently and at 6.6X 2006E EV/DACF trade at a premium to the small-cap E&P average of 6.1X. We believe Berry's above-average returns and attractive growth opportunities in the Rockies justify this premium, but further multiple expansion would in our view require either some additional exploration success or better than expected execution with development assets, with the Piceance having potential to be especially impactful, positively or negatively.
4Q 2005 RESULTS BELOW EXPECTATIONS
Berry reported 4Q 2005 operating and financial results below expectations. EPS was $1.35, below our estimate of $1.55 and the First Call consensus of $1.60. Operating cash flow was $49.9 million, below our estimate of $56.2 million. Production of 23.7 MBOE/d was essentially in line with our estimate of 23.8 MBOE/d. All-in unit costs of $23.78 per BOE were above our estimate of $19.87 per BOE.
UPDATING ESTIMATES
We are updating 2006-2010 EPS estimates to reflect revised assumptions for production, realized commodity prices, and unit costs. Our 1Q, 2Q, 3Q, and 4Q 2006 EPS estimates are now $1.75, $1.81, $1.88, and $2.30 versus $1.69, $1.78, $1.85, and $2.27 previously, and our full-year 2006 EPS estimate is now $7.74 versus $7.59 previously. Our 2007 EPS estimate is now $8.95 ($8.33 previously). Our 2008 (normalized) EPS estimate is now $4.15 ($4.09 previously). Our 2009 (normalized) EPS estimate is now $4.45 ($4.35 previously). Our 2010 (normalized) EPS estimate is now $3.40 ($3.29 previously). See exhibit 1 for our Berry summary financial model.
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, Brian Singer. |
