Noble Energy (IL/A): Development in Rockies, exploration in Equatorial Guinea key to upside in the coming years - Goldman Sachs - February 24, 2006
Noble Energy's lower-risk onshore growth combined with steady international gas production and deepwater Gulf of Mexico project startups should generate strong free cash flow over the coming years, and Noble's high free cash yield could prove to be an advantage relative to its peers if natural gas prices stagnate in the short term. While some of Noble's mid- and small- cap peers have shied away from deepwater exploration to focus on onshore unconventional gas basins, Noble is expected to be active in exploration in the Gulf of Mexico and Equatorial Guinea, with results expected to be a key catalyst for the stock. While we favor Newfield Exploration (OP/A) among diversified offshore/onshore E&Ps due to more attractive valuation, we nevertheless see 41% upside potential to a $59 traditional peak value for Noble. We rate Noble In-Line relative to an Attractive coverage view.
Key company-specific catalysts
(1) Growth from Patina assets and longer-term impact of downspacing. To stabilize onshore cash flows in the US and add multiyear drilling inventory, Noble acquired Patina Oil and Gas in 2004 and proceeded to drill aggressively in 2005. We view the recently announced acquisition of US Exploration as a sign that Noble feels confident enough in its expertise in the Wattenberg field to commit additional acquisition capital. The combined Patina/US Exploration assets should yield long-lived reserves, free cash flow and sustainable double-digit growth; from 2006 to 2010, we believe Patina and US Exploration production will make up about 40% of total production, pushing production growth to about 14% a year. As Noble adds additional rigs, we believe execution and results from 20-acre downspacing longer term will be key for Noble to receiving greater credit.
(2) Lorien, Ticonderoga, and GOM deepwater exploration. The startup of Lorien in 2Q 2006 and the recent (earlier-than-expected) startup in Ticonderoga should generate near-term free cash flow and production growth in 2006 and 2007. On the conference call, the company did not indicate any further timing issues related to the development of Lorien. Combined production from Lorien and Ticonderoga in 2006 and 2007 is expected to be 9.8 Mb/d and 24 Mb/d respectively, which are 5% and 10% of total U.S. production and are essentially driving non-Patina production growth over the next two years. Noble plans to drill 3-4 deepwater exploration wells this year, one of which is the Red Rock prospect that has already spud. Given generally mixed exploration results over the last year, success would be a key catalyst for the stock by extending offshore production growth beyond Lorien and Ticonderoga.
(3) International expansion, notably in Equatorial Guinea. In Equatorial Guinea, we see longer-term production growth potential from Noble's deepwater prospects. Noble successfully drilled the Belinda exploration well in Block O, and appraisal/testing should start this year. Additional exploration in neighboring Block I should begin in 3Q 2006. We believe that the timing is such that when Lorien and Ticonderoga begin to decline in 2008, development in Equatorial Guinea could start soon after. This has the potential to smooth otherwise lumpy deepwater production. In Israel, Noble plans to build infrastructure over the next few years to support increasing natural gas demand driven by industrial plant demand, though with minimal expectation for proved reserve additions.
Valuation
Noble currently trades at 2006 EV/debt-adjusted cash flow of 4.3x, a discount to the group average of 6.3x. Given our confidence in the quality of Noble's assets and its diversification, we believe that this discount stems from investor's anxiety in the development of the Rockies due to Noble's perceived lack of expertise in unconventional gas. We see 41% upside to a $59 traditional peak value and 104% upside to a $86 super-spike peak value. While Noble's net debt/total capitalization stands at 46%, we expect that to fall as the company pays down Patina/US Exploration-related debt with its free cash flow. We believe that Noble will look to get net debt/total capitalization to the mid-30% levels before considering any share buybacks.
4Q 2005 adjusted EPS weaker than expected Noble reported 4Q 2005 adjusted EPS of $1.18, below our estimate of $1.21 and First Call consensus estimate of $1.23. Production was lower than expected at 159 MBOE/d versus our estimate of 168 MBOE/d, driven by lower than expected oil production. Realized prices were generally in line. Total costs were higher than expected at $20.88 per BOE versus our estimate of $17.65 per BOE, driven by higher than expected exploration expense. Noble's operating cash flow for 4Q was $416 million versus our estimate of $442 million.
Updated estimates We are introducing quarterly estimates for 2006, as well as updating our full-year 2006, 2007, and 2008-2010 (normalized) estimates to reflect our lowered 2006 natural gas price assumption of $9.50/MMBtu ($10.00/MMBtu before). Our estimates also reflect the effects of the U.S. Exploration acquisition, changes in costs and production, and minor other company adjustments. Our new 1Q, 2Q, 3Q, 4Q estimates for 2006 are $1.14, $1.26, $1.51, and $1.86, respectively. Our updated full-year 2006 and 2007 estimates are $5.78 ($6.32 previously) and $7.01 ($7.33 previously) respectively. Our 2008-2010 (normalized) estimates are $2.73 ($2.96 previously), $2.71 ($2.95 previously), and $2.99 ($3.26 previously) respectively. Exhibit 1 shows our summary financial model for Noble.
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 Murt |
