Chevron (IL/A), Exxon Mobil (OP/A): Analyst meeting previews--Though upside is similar, we prefer XOM over a de-rated CVX - Goldman Sachs - March 01, 2006
With both Chevron (IL/A) and Exxon Mobil (OP/A) having underperformed the S&P 500 by 12%-14% over the past year despite a roughly $10/bbl increase in WTI oil, risk/reward for the shares appears quite attractive with both stocks showing over 35% upside to "traditional" peak values. Among the US- based super-cap oils we continue to favor XOM as the superior low-beta offset to our preferred high-beta domestic oil/E&P/R&M top picks given its industry-leading profitability, robust fundamental outlook, and strong management team. We are resisting temptation with CVX, as investors appear to have logically de-rated it relative to XOM given weak E&P fundamentals and the risk of returns dilution if additional acquisitions are required. We do not expect the upcoming March 7 and 8 analyst meetings for Chevron and Exxon, respectively, to be meaningful catalysts.
CHEVRON "DE-RATING" LIKELY A CONTINUATION OF INVESTOR SKEPTICISM OVER ITS E&P OUTLOOK THAT BEGAN IN 2000
Although there has been increasing investor attention to Chevron's relative valuation discount to the super-cap oil peer group recently, we believe investor concerns about the potential for Chevron's deteriorating fundamentals likely began in 2000. Poor 1999 organic reserve replacement--reported in early 2000--and the subsequent announcement of the Texaco merger in October of 2000 we believe eroded investor confidence in Chevron's ability to organically grow its reserves base or at a minimum replace produced volumes at competitive returns. Note, Chevron shares performed similarly to the peer group in 2000-2001, but investors appeared unwilling to capitalize Chevron's higher relative earnings performance during that period (see Exhibit 1).
In our view, Chevron's disappointing 2004 and 2005 reserve replacement via the drillbit, combined with the acquisition of Unocal, exacerbated lingering investor concerns about Chevron's organic E&P prospects. It is not that we, nor likely the Street, believe acquisitions to be inherently value-destroying or that reserve bookings in any one or two given years are necessarily indicative of the underlying resource base. However, if the company is incapable of at least 100% organic reserve replacement, the market is rightfully concerned that acquisitions will need to be made possibly from a position of weakness with the risk of dilution to incremental returns on capital. In regards to reserve replacement data, given the increasing size and long lead-time of E&P projects, it is only natural to expect lumpy reserve bookings. However, we note that Chevron's organic reserve replacement ranked in the bottom-quartile for most of the 1999-2005 period.
DOES CHEVRON HAVE SUFFICIENT LOWER-RISK "BREAD-AND-BUTTER" EXPLOITATION PROJECTS TO OFFSET DECLINES IN ITS BASE PRODUCTION?
Our analysis of the industry's next generation legacy assets appears to indicate that Chevron has a relatively attractive position but that the impact of the projects are likely not meaningful until the 2008+ period (for more details, please see our February 16, 2006 Global Energy Investment Research report, "125 projects to change the world: Key issues from our annual review"). As such, we believe the concern is not so much as to whether Chevron has sufficient future projects, but rather one of timing and magnitude of the decline rate in its base production that could undermine near-term E&P metrics as well as the future benefits from longer-term projects. In our view, Chevron's bottom-quartile organic reserve replacement over the past several years may indicate that a combination of faster-than-expected production declines or insufficient lower-risk "bread-and-butter" exploitation offset could be taking place. Until Chevron can show positive organic growth, investors are likely to take a wait-and-see approach with Chevron shares.
CHEVRON ANALYST MEETING LIKELY NOT A MEANINGFUL CATALYST, THOUGH IT IS AN OPPORTUNITY TO SHOWCASE ITS E&P PORTFOLIO WHICH OTHERWISE MAY BE MISUNDERSTOOD BY THE STREET We do not expect Chevron's analyst meeting on March 7, 2006 to be a meaningful catalyst for its shares. We expect management to re-iterate estimated production capacity growth of 3% per annum through 2010 excluding the impact of acquisitions, similar to the guidance given at its previous analyst meeting in December 2004. We expect no change to Chevron's announced $14.8 billion capital and exploratory budget for 2006. In our view, perhaps more important would be management color on the potential for higher-than-expected resources from Unocal assets, progress on Chevron's various E&P programs, merger integration update, and greater detail regarding its 2005 reserve data.
Regarding CVX's production growth objective, we note that it like almost all of the super-cap oils with the exception of Total (and Occidental Petroleum if it were to be included in this group) has badly missed its past guidance even after adjusting for asset sales and production sharing contract (PSC) pricing effects. As such, we think evidence that Chevron can actually grow production organically will be an important milestone and possible catalyst for the shares. However, we do not see that occurring in 2006 as we estimate production will decline 1% relative to an adjusted 2005 base-line that assumes a full-year of Unocal production. In our view, the upward production growth inflection could happen in 2007 as we expect +2% growth followed by mid-single digit growth in 2008 and 2009. Given its past track record, risk to our forecasts are almost certainly skewed to the downside.
EXXON MOBIL: THE LAST TRUE SUPER MAJOR?
For investors not wishing to immerse in a debate of whether or not Chevron is undeservedly inexpensive, or who are more risk-averse and unwilling to invest in our top higher-beta domestic oil/E&P picks, we believe Exxon Mobil shares offer an attractive risk/reward in a company with a track-record of industry-leading profitability, capital discipline, and cash returned to shareholders. In our view, Exxon's long history of double-digit ROCE even when WTI oil prices averaged less than $15 per barrel distinguishes it from any other oil company. Indeed, we wonder if Exxon's risk-adjusted returns profile is not better than most super-cap darlings outside of the energy sector.
EPS REVISIONS AND MARKET PERFORMANCE THE TWO KEY DRIVERS FOR EXXON SHARES
Despite efforts by the Street (including ourselves) to forecast normalized profitability, E&P production profile, CAPEX, and other key oil and gas metrics, two simple factors have been the overwhelming drivers for Exxon's share price performance: its 1-year forward EPS outlook and the absolute level of the S&P 500. The two factors combined can account for 96%-98% of the weekly variability in Exxon share price over the past 15 years, with a standard error of 5%-7%. Consistent with previously published notes, the analysis would imply that EPS revisions--which we believe to be biased upward over the intermediate term given our bullish commodity outlook--should continue to drive Exxon shares (and the oil sector broadly) higher. Note, the First Call consensus estimates of $5.77 for for Exxon's 2006E EPS and $58 per barrel for WTI oil compare to our $6.50 2006E EPS forecast (assumes $68 per barrel WTI oil) and the NYMEX 1-year WTI oil strip of $65.50.
EXXON ANALYST MEETING LIKELY NOT A MEANINGFUL CATALYST FOR SHARES
Although it will be Exxon's first analyst meeting since the retirement of Lee Raymond, we do not expect any changes to Exxon's business model or financial strategies. Rather, we expect Exxon to continue emphasizing its tried-and-true long-term focused business strategy that has served shareholders well over the decades. In terms of its E&P production outlook, we believe 2006 could be an inflection year for Exxon. We estimate +2% organic volume growth in 2006, with annual growth rates accelerating to 3%-4% through 2008. Note, Exxon's 2005 volumes were down roughly 1% versus 2004 levels adjusted for storm impacts, asset sales, and entitlement effects, and largely in-line with management guidance of flattish production at its previous analyst meeting. We expect management to guide towards a $20 billion (+12% year-over-year) capital program for 2006, with the increase driven by higher investments in E&P and chemicals.
VALUATION: WE SEE 36% AND 39% UPSIDE TO "TRADITIONAL" PEAK VALUES FOR CHEVRON AND EXXON, RESPECTIVELY
Although our bullish commodity outlook continues to favor our higher-beta domestic oil/E&P top picks, we believe inexpensive super-cap oil valuations are making an increasingly compelling case for ownership of the super-caps. From a risk/reward perspective, we see on average 38% upside to "traditional" peak values which imply a $45 per barrel long-term WTI oil, and 11% upside to "traditional" mid-cycle values which imply a $35 per barrel long-term oil. This compares to the domestic oils/E&Ps showing 25% upside to "traditional" peak and 6% downside risk to "traditional" mid-cycle values.
For Chevron, we see +9%/+36% upside to $60/$75 "traditional" mid-cycle/peak values, respectively. Note, we have lowered our estimated mid-cycle/peak values for Chevron from $69/$86 previously to reflect our view that its de-rating relative to Exxon is both appropriate and unlikely to change in the next year or two. We estimate Chevron trades at 4.8X 2006E and 4.3X 2007E EV/DACF (enterprise value to debt-adjusted cash flow), which compares to the respective super-cap integrated oil average of 5.7X and 4.3X.
For Exxon Mobil, we see +12%/+39% upside to $65/$81 "traditional" mid-cycle/peak values which imply a 12.5X/10.0X 2006E P/E, respectively. In our view, with investors likely to ratchet-up long-term oil price expectations in 2006, we believe the 10X-12.5X 2006E P/E could prove conservative. See Exhibit 2 for comparative risk/reward and valuation. See Exhibits 3-4 for summary financial models for Chevron and Exxon Mobil.
Goldman Sachs & Co. and/or one of its affiliates is acting as financial advisor to ConocoPhillips in the proposed acquisition of Burlington Resources Inc. Goldman Sachs & Co. and or one of its affiliates will receive a fee for its financial advisory role.
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. |
