Occidental Petroleum (OP/A): Analyst meeting affirms favorable outlook for Oxy shares - Goldman Sachs - February 23, 2006
We came away from Occidental Petroleum's analyst meeting continuing to believe that Oxy is very well positioned for what we believe would be increasing investor confidence in a high sustained oil price environment. In our view, if there is one company in which investors can have confidence in the combination of reserves and production growth, top-quartile returns, capital discipline, and free cash flow over the intermediate- and long- term, it is Oxy. Indeed, if investors ratchet-up long-term WTI oil price assumptions toward $60/bbl, as we expect, we believe investors are more likely to capitalize such earnings potential for Oxy than most other E&P companies. We see 61% upside to our $143 "super-spike"-adjusted peak value, which implies a $60/bbl long-term WTI oil price. Assuming a $45/bbl long- term oil price we see 24% upside to our $110 "traditional" peak value. Oxy remains OP/A rated.
For additional details on our view on Occidental Petroleum, please see our report published on May 26, 2005, "Upgraded to OP given reloading of its E&P portfolio" Message 21360559 , our note published on October 14, 2005, "Oxy to acquire Vintage Petroleum" Message 21794600 , our note published on November 1, 2005, "E&P portfolio positioned to resume multi-year growth at industry-leading ROCE" Message 21844140 , our note published on January 30, 2006, "E&P portfolio reloaded, relative valuation inexpensive, reinstating view with OP/A rating following a period of Not Rated" Message 22118708 , and our note published on February 14, 2006, "Analyst meeting preview--Enhancing confidence in the enhanced oil recovery strategy" Message 22169203 .
E&P PRODUCTION GUIDANCE SLIGHTLY HIGHER-THAN-EXPECTED, CAPEX GUIDANCE LOWER-THAN-EXPECTED
What was pleasantly surprising about Oxy's analyst meeting was its guidance of a slightly higher-than-expected E&P production growth coupled with lower-than-expected CAPEX projections. For most other major oil and E&P companies, recent guidance has been the exact opposite--lower production and higher CAPEX. Oxy's base-case 2010 E&P production guidance of 795,000 BOE/d (+6% CAGR from year-end 2005) adjusted for effects of production sharing contracts (PSCs) compares to our 790,000 BOE/d forecast. Our overall E&P production estimates for Oxy remain largely unchanged today, although we have made minor adjustments to regional production details.
In terms of capital expenditures, Oxy's $3.1 billion total budget for 2006 was roughly 10% below our $3.4 billion estimate. More impressive was management's expectations of a 5%-12% per annum decrease in expected capital expenditures despite a growing E&P production base. By 2010, management expects base-case CAPEX to be $2.3 billion (down 27% from the 2006 peak), which compares to our estimate of $3 billion and excludes potential additional projects.
ADDITIONAL POTENTIAL E&P PROJECTS COULD ADD 115,000+ BOE/D TO PRODUCTION FOR 2010
Management highlighted new potential projects in the Middle East--currently in preliminary discussions with host countries and not included in base-case production forecasts--that could add 50,000-75,000 BOE/d to its 2010 E&P profile on a risk-adjusted basis. Oxy also expects that potential exploration success particularly in Libya could add an incremental 20,000-40,000 BOE/d. Oxy intends to spud its first exploration wells in Libya in 2H 2006. Assuming the new project profile, Oxy could achieve a 2010 E&P production rate of 900,000+ BOE/d (+9% CAGR from year-end 2005).
Outside of the Middle East region, we continue to believe that the potential for enhanced oil recovery (EOR) activities in California could meaningfully boost its production profile. Though management did not give much details in the potential for tertiary recovery via CO2 flooding at its giant Elk Hills field, we believe it could raise the ultimate recoverable resource by potentially as much as 1 billion BOE over the long-run.
RETURNS ON MIDDLE EAST PROJECTS LIKELY TO REMAIN ROBUST
We continue to feel confident that returns on capital from its new Middle East projects will remain far more robust than consensus appears to believe. In our view, the high returns Oxy has been enjoying from its legacy Middle East projects (23%-40% ROCE during a $26-$57 per barrel WTI oil price environment) is due to Oxy's focus and expertise in EOR projects which limit exploration risk and cost inflation while increasing ultimate recoverable resources. As such, we think the perceived high government take is not the risk to Middle East returns, but rather Oxy's ability to continue to replicate its success in EOR project execution. That is, as long as investors are confident Oxy can increase total recoverable reserves in a field, which we believe it can given its long track-record, superior returns should follow.
In terms of political risk for the regions Oxy is involved in, we continue to believe that Oxy is not over-exposed to any one country or region. In our view, the likelihood that Oxy production is meaningfully affected without a subsequent rise in world oil prices to the benefit of Oxy's remaining 60%-80% of its production would overwhelmingly offset output loss. Further, the benefit of a large, attractive resources base and superior risk-adjusted and absolute returns (as its legacy assets have shown) in our view far outweigh the perceived negatives of geopolitical risk.
EXPANDED SHARE REPURCHASE PROGRAM A POSITIVE FOR OXY SHARES
Although we believe Oxy's expanded share repurchase program is more likely driven by current circumstances--i.e., high commodity prices and low debt--as opposedto a shift in management philosophy in its use of free cash, we believe it is nonetheless positive for its shares as investors will feel more comfortable that management will return cash back to shareholders and not "chase" acquisitions due to flush cash balances. Although management has talked about the potential for bolt-on acquisitions, we believe the expanded share repurchase program signals management's willingness to reduce its capital base prudently when growth/acquisitions become too expensive and detrimental to its traditionally superior long-term returns. The scope of Oxy's share repurchase program is now 30 million shares (10 million previously) which, assuming a roughly $100 average Oxy share price, entails a $3 billion program.
VALUATION DISCOUNT TO PEER GROUP UNSUSTAINABLE, IN OUR VIEW
We see Oxy shares currently trading at 4.6X 2007E EV/DACF (enterprise value to debt-adjusted cash flow), 6% below the peer group average of 4.9X. In our view, given Oxy's superior combination of growth, returns (absolute and risk-adjusted), and free cash flow, the valuation discount is unlikely to persist over the medium- to long-term.
$60 PER BARREL LONG-TERM WTI OIL PRICE WOULD IMPLY 61+% UPSIDE FOR OXY SHARES
We estimate at least 61% upside to a $143 "super-spike"-adjusted value for Oxy shares, which is reflective of $60 per barrel long-term WTI oil price. Although nearly all oil equities exhibit substantial upside should investors ratchet-up long-term oil price expectations to a $60 per barrel level, we would note that Oxy's long-lived asset base, low capital intensity, superior profitability, and robust pipeline of potential reserve additions greatly increase the likelihood that investors will capitalize Oxy's earnings power from such an environment. Assuming a $45 per barrel long-term WTI oil price, we estimate 24% upside to a $110 "traditional" peak value.
UPDATING ESTIMATES
We are updating our 2007-2010 EPS estimates for Oxy, which now stand at $14.50 ($14.00 previously), $6.90 ($6.65 previously), $7.70 ($7.35 previously), and $8.65 ($8.29 previously), respectively. Our updated estimates reflect lower assumed capital expenditure, larger expected share repurchase program, updated production profile, and minor other adjustments. See Exhibit 1 for comparative risk/reward. See Exhibit 2 for a summary model of Occidental Petroleum.
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. |
