Description
Let me start with a confession: I think it is different this time: Energy prices are going to remain quite high relative to historical levels. NYMEX long-term futures are a better guide to what lies ahead than the history of the last twenty years. The crux of this argument is simple: there is minimal spare capacity in the system, unlike other periods in which pricing was artificially supported, and strong economic growth in Asia will drive the demand side of the equation.
But what if the futures curve is very wrong? In that case, successful energy investing will require more than a dartboard. Pioneer Natural Resources is both cheap enough and blessed with surfficiently attractive growth prospects that it should be a decent investment even if energy prices settle back to the $5 gas and $30 oil embedded within sector valuations.
Pioneer came into being in 1997 when Parker & Parsley acquired Mesa Petroleum. The next year the newly named company, already quite levered, took on more debt to acquire Chauvco Resources, a Canadian independent, just ahead of the upheaval in Asian financial markets and the ensuing collapse in commodity prices. Major cost reductions and noteworthy drilling success in the Gulf of Mexico repositioned the company by 2002. Production grew by 36% in 2003 and averaged 12%/year over the 5 years from 1999 to present.
This May, Pioneer announced a merger with Evergreen Resources, a rapidly growing coalbed methane company operating in the Raton Basin (southern Colorado and New Mexico). While the deal was not particularly expensive on reserve value ($1.40/MCF), at 7.5X cash flow it was a more expensive multiple than most recent transactions in the sector. In addition, as the deal was part stock and part cash, Pioneer both took on additional debt and added hedges at what turned out to be less than optimal prices to protect its cash flow.
Since the announcement, PXD has significantly lagged its peers. I believe that both companies’ shareholders were put off by the deal: Pioneer’s because of the apparent dilution and additional debt burden and Evergreen’s because of the lack of a premium in the deal and the reduction in growth rate. Management attempted to justify it on three key points: (1) Evergreen’s production is on a steep growth curve (roughly doubling over the next 5 years; (2) relatively little capital investment is required to generate this growth. and (3) the deal was accretive to free cash flow in 2005.
I did not own PXD before the deal, but I think that the management argument is a pretty good one. More importantly, the resultant company is quite attractive and very cheap. At current prices, one is buying proved reserves at $1.18/MCF--much lower than the norm for E&P companies today. Furthermore, I think that management makes a solid case for high single-digit production growth over the next 4 years (see the 10/20 Investor Presentation available on the website). At current strip pricing, this will produce $2.6 billion of excess cash flow between 2005-2008, which is more than current total debt or over half of the total equity value of the company. Looked at another way, in 2005 PXD should have a free cash flow yield between 13-15%.
PXD is buying back stock aggressively, which is very accretive to shareholders at current prices. Management is taking another portion of free cash flow and paying down debt--the goal being to reach minimum investment grade rating in 2005. I suspect major acquisitons are unlikely (but this is a potential risk factor), but PXD has a solid record of minor property acquisitions and disposals to rationalize its asset base.
Fizz808 wrote up Anadarko Petroleum a few weeks ago. I own Anadarko and like it, but I believe that PXD is a more interesting investment opportunity today. In fact, PXD reminds me a little of APC 12 months ago, when the stock was in the $40s and it was much more controversial than it is today.
Catalyst
1. Aggressive share repurchase boosts intrinsic value.
2. Solid execution.
3. Further exploration success--especially in the Gulf of Mexico.