Noble Energy (IL/A): Offshore exploration results to determine use of strong free cash flow - Goldman Sachs - May 19, 2006
We believe that strong cash flows from recent startups in the deepwater Gulf of Mexico combined with US onshore growth and stable international production will provide Noble Energy with meaningful free cash flows and optionality as to its future direction. Following the company's analyst meeting, we continue to be impressed with the level of risk management used in both exploration and development that allows a mid-cap company to be competitive in the Gulf and internationally. We expect exploration, principally in Equatorial Guinea but also in Suriname, to be the key catalyst both to Noble shares and for the company in determining how free cash will be used. We rate Noble IL/A, though increasingly the shares look attractive among conventional E&Ps that trade at very similar multiples.
DEEPWATER STARTUPS COMPLETE WHILE INTERNATIONAL PRODUCTION, CASH FLOW STABLE
We believe Noble's free cash flow will be significant over the next two years, and its free cash yield of 12% in 2006 and 17% in 2007 is among the highest among E&Ps. This is in part driven by the recent startups of the deepwater Gulf of Mexico Swordfish, Lorien and Ticonderoga projects. We expect production from these three fields to be flat through 2007 before beginning declines. Internationally, Noble's production in Israel, Equatorial Guinea and Ecuador is relatively stable, despite recent turbulence in each respective surrounding region.
CONTINUED CONFIDENCE ONSHORE GROWTH IS ON TRACK
We continue to have confidence in Noble's onshore production growth, and we expect about 10% production growth from Patina Oil and Gas and US Exploration assets. Downspacing in the Wattenberg field seems on track, and Noble's early recognition of this potential allowed it to outbid others to win US Exploration earlier this year. The success of this acquisition is contingent on continued success from Wattenberg downspacing, and its cost-effective program of refracing and trifracing wells. Outside of the Rockies, Noble continues to develop its Buffalo Wallow and Billy Rose fields with success. The addition of the Patina assets has given Noble significant onshore drilling inventory that lowers overall company risk, and the company has generally met its objectives without any hiccups. Total company production guidance for 2007 of 190-210 MBOE/d seems conservative in our view.
EXPLORATION KEY CATALYST FOR USE OF FREE CASH FLOW, EXPANSION
We believe the company's offshore exploration program will be a key catalyst over the next year. Following Noble's Belinda discovery in Block O in Equatorial Guinea, the company is currently drilling an appraisal well and will also drill the neighboring Adriana prospect this year. Once done, a more accurate estimate of ultimate recovery from the Belinda area is likely to be determined. The greater the presence of oil/condensate relative to natural gas, the more valuable the discovery and the sooner the likelihood of development. The company recently disclosed the presence of a deeper oil-bearing channel at Belinda, which management believes extends into the Adriana prospect. If Blocks O and I are ultimately commercial principally from natural gas, management did not rule out the possibility of becoming more involved in LNG, although its base case is to only be involved as presently in upstream and methanol production. In the Gulf of Mexico, the company's Redrock discovery is being evaluated for commerciality while neighboring Raton is being drilled. In addition to results from these wells, management is very active in pursuing subsalt prospects which if successful would meaningfully improve Street views on Noble's deepwater Gulf exploration strategy in our view. In Suriname, the company plans to drill its first well in late 2007. Successful exploration would provide development opportunities for Noble's cash flow. Otherwise, we believe the company may become more active in pursuing acquisitions or increasing share repurchase.
VALUATION: CONVENTIONAL E&Ps TRADE AT PARITY
There is minimal differentiation in valuation among conventional E&Ps, despite differentiation in company quality and returns. Noble, Newfield Exploration, Pogo Producing, Devon Energy, Talisman Energy and Apache each trade at relatively similar EV/debt-adjusted cash flow multiples (about 4.8x in 2006, 3.8x in 2007 and 5.5x in 2008 normalized). We continue to prefer Newfield Exploration (OP/A) among conventional E&Ps because of the strong rate of change in Newfield's production growth visibility that we believe remains underappreciated. Noble is also exhibiting strong medium-trends, with exploration as the main catalyst. We remain neutral on Devon, Talisman and Apache (each IL/A). Increasingly, we believe Pogo (IL/A) should trade at a discount to these peers until the company can show both returns improvement and exploration success in Canada.
UPDATED ESTIMATES
We are updating our 2Q, 3Q, 4Q and full-year 2006-2007 EPS estimates to reflect the pending Gulf of Mexico shelf asset sale and minor other company adjustments. Our new estimates are $1.16 ($1.13 previously), $1.34 ($1.51 previously), $1.60 ($1.81 previously), $5.36 ($5.71 previously), and $6.69 ($7.88 previously) respectively. We are also updating our 2008-2010 (normalized) EPS estimates to $2.85 ($3.09 previously), $2.84 ($2.90 previously), and $2.94 ($3.06 previously) respectively
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. |
