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Gold/Mining/Energy : PIONEER NATURAL RES. (PXD) -- Ignore unavailable to you. Want to Upgrade?

To: Dennis Roth who wrote (187)	3/7/2006 8:38:05 AM
From: Dennis Roth	Read Replies (1) \| Respond to of 233

Pioneer Natural Resources (IL/A): "Show me the probables."; report published - Goldman Sachs - March 06, 2006 Our view of the attractiveness of Pioneer shares has improved, though only due to valuation as opposed to any greater belief in longer-term returns and growth. We continue to have concerns regarding the origins and returns of proved reserve additions, given the company's high level of proved undeveloped reserves. We continue to rate Pioneer In-Line relative to an Attractive coverage view, though we see 44% upside to a $63 traditional peak value, which we think could be achieved only as management meets key targets over multiple quarters. Please see our detailed 23-page report, "Show me the probables." If you are on our e-mail distribution list, a.pdf will be sent today. RECENT HISTORY: PERCEIVED BROKEN PROMISES, SHORT TERM FIX ATTEMPTS Pioneer has been a multi-year underperformer. Over the last two years, Pioneer shares have increased 35% while other E&Ps and integrateds have risen 124%. The main reason for Pioneer's underperformance, in our view and that of the Street, is the general perception of Pioneer's changing strategies, from its seeming disinterest in a large acquisition shortly before the Evergreen Resources acquisition announcement to the company's confidence in its Gulf of Mexico profile shortly before reducing guidance because of Gulf declines to ultimately its announcement that it would sell its Gulf of Mexico interests entirely. For the last year, management has listened to activist market participants. With covert shareholder activism over the last year, Pioneer responded to many shareholders' views that the company should try to monetize future resource through the use of volumetric production payments (VPPs). Pioneer announced three VPPs during 2005, leading to the sale of 28 million BOE of reserves for upfront proceeds of $893 million. Pioneer still must incur the operating costs associated with those barrels, and we estimate the present value of these costs at $364 million or $2.75 per share. Ultimately, the VPPs were not well regarded by fixed income investors and did little to convince equity investors of the quality of Pioneer's underlying assets. As confidence in Pioneer's offshore position waned further, the company announced it would sell its Gulf of Mexico interests along with parts of its Argentina position. Asset proceeds greater than expected. The $1.8 billion in expected after-tax proceeds from the sale of Gulf of Mexico and Argentina assets are above expected levels, although we would note that Pioneer shares did not outperform on the two days when these deals were announced. We believe this sluggishness reflects continued Street concern for capital discipline and investable opportunities at Pioneer. We expect that allaying these concerns will be a key focus at the analyst meeting. THE FUTURE: ASSET QUALITY MOST IMPORTANT CATALYST We expect double-digit production growth over the next five years. We see Pioneer growing 11.4% per year from 2006-10 after stripping out Gulf of Mexico and Argentina production from 2005 and 2006. We believe the company will introduce a double-digit growth target at its analyst meeting. Because onshore production was in slight decline over the course of 2005, year-on-year onshore growth in 2006 is expected to be relatively small, though rising to double-digit levels in 2007. Most of company's medium-term inventory is booked as proved reserves already. Because of relatively high proved undeveloped (PUD) reserve bookings in key growth fields, we see more limited probable reserves than we do for other E&Ps. We believe the Spraberry field in West Texas, the Raton Basin in Colorado and the South Coast gas project in South Africa will be the largest drivers of production growth over the next three years. We are valuing probable reserves from Alaska and the Horseshoe Canyon, but we remain concerned that there could be another year of poor reserve replacement in 2006 as some of these projects are unlikely to be booked this year. Emerging onshore resource plays seem exploratory for now, and success is needed to justify outperformance, in our view. We believe the company will provide greater detail on its plans for drilling on its Lay Creek acreage in the Sand Wash Basin, the Columbine Springs acreage in the Piceance Basin, the Castlegate acreage in the Uinta Basin and the Edwards Trend in South Texas. For now, we do not consider these plays in development. If the company were to announce specific well results that show enough critical mass, we believe Pioneer shares would rise. VALUATION: ATTRACTIVE ON PROVED RESERVES, EXPENSIVE ON CASH FLOW We believe discounted cash flow analysis that considers impact of abnormal liabilities is key to valuing Pioneer. Pioneer has an estimated $7.25 per share or so of liabilities, about $6.50 per share of which are somewhat unique to Pioneer (related to the present value of VPP costs and hedging losses). We believe that these liabilities should be considered in Pioneer's valuation as opposed to solely considering net debt. Additionally, discounted cash flow analysis that considers the timing of when the company's resource will be produced is our preferred method of valuation. Pioneer's seemingly attractive proved reserve valuation looks more appropriate when considering liabilities, discounted cash flow. We believe Pioneer today trades at about $1.33 per Mcfe of proved reserves after adjusting for the present value of VPP costs and hedging losses and the sale of Gulf of Mexico/Argentina. This is attractive relative to most peer companies that trade between $1.75-$2.15 per Mcfe. However, we believe some discount is appropriate for three reasons: * The more drawn-out time over which onshore proved developed reserves are expected to be produced (in part because of volumetric production payments) reduces the present value of those proved developed reserves. * The greater level of proved undeveloped reserves and their associated costs dilute the overall present value of proved reserves. * We see less visibility in Pioneer's probable reserves than we do for other E&Ps; Pioneer's EV/proved + probable (+ possible) reserves are not at a discounted multiple. Pioneer trades at 5.0X 2007E EV/debt-adjusted cash flow, representing a premium to the 2.9x-5.5X multiples of its peers. We see 44% upside to a $63 traditional peak value versus 32% for other conventional E&Ps. Our discounted cash flow-based net asset value suggests a mid-cycle value of $46 per share and a traditional peak value of $63 per share. This represents meaningful upside, though somewhat in-line with other more diversified/conventional E&Ps that have sold off. Mid-cap conventional E&Ps consistently are the sub-segment with the most upside (see Exhibit 2). We prefer Newfield Exploration and XTO Energy (both rated OP/A) among more diversified producers and Southwestern Energy and EnCana (also OP/A) among unconventional gas companies. However, due to both Pioneer's underperformance and greater-than-expected proceeds from the Gulf of Mexico, our view of Pioneer's valuation and upside has improved. Greater confidence in probable/possible inventory is the catalyst for outperformance and for upside to our traditional peak value. See Exhibit 2 for our comparative projected returns analysis. 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 Murti