Growth, resource emergence, lower spending would yield upside - Goldman Sachs - August 06, 2007
What's changed
Chesapeake reported 2Q 2007 adjusted EPS of $0.71 versus our $0.70 and First Call consensus of $0.65. Total production was 1.87 Bcfe/d versus our estimate of 1.83 Bcfe/d. Operating cash flow was $1.08 billion versus our $1.04 billion. Management raised production and spending guidance.
Implications
Chesapeake continues to aggressively grow production and beat guidance. With Barnett Shale production in particular growing faster than expected for Chesapeake and most of its large peers, as well as Chesapeake's increased success in the Fayetteville Shale, the company can continue to receive more credit for its vast investment in unproved properties over the past 2-3 years. Chesapeake was one of the best performing stocks on August 3, due in part to the strong 2Q results and in part to comments from management that it expects more balanced free cash flow in 2009. If Chesapeake can maintain a high single-digit growth rate and have E&P spending within E&P operating cash flow, we believe the stock can outperform. We believe it is too early to assume this for now.
Valuation
Chesapeake shares (Neutral rated) trade at 5.0x 2008 EV/debt-adjusted cash flow versus 5.4x for Anadarko Petroleum, 4.8x for Devon Energy, 5.2x for EOG Resources, 6.1x for XTO Energy and 6.6x for EnCana (excluding its oil sands business). We believe the premium valuations at which EnCana and Anadarko currently trade versus Chesapeake are too wide. We see meaningful upside to Chesapeake shares if its returns and free cash profile improve. Chesapeake shares are at our $35 12-month discounted cash flow based target price. We see 1% downside for large-cap E&Ps and 8% upside for E&Ps overall.
Key risks
Commodity price volatility, drilling results, cost pressures and government pronouncements are key risks. |
