Despite high volatility and macro uncertainty, the Street is still bullish on Canadian Natural (NYSE:CNQ), Penn West (NYSE:PWE), and EOG. All three companies are rated a "buy" due to recent operational improvements that have positioned them well to exploit positive secular trends. Based on my review of the fundamentals and DCF model, I find attractive upside for Canadian Natural and Penn West.
From a multiples perspective, it is difficult to gauge the extent to which the companies are discounted to intrinsic value. Canadian Natural trades at a respective 26.6x and 10.5x past and forward earnings; Penn West trades at a respective 14.7x and 31.6x past and forward awnings; and EOG trades at a respective 29.6x and 24.3x past and forward earnings. Penn West has, by far, the highest dividend yield at 4.9% but this is a matter of concern given that the payout ratio exceeds 70%.
At the third-quarter earnings call, Canadian Natural's management stated:
Q3 '11 was a quarter of strong cash flow generation and operational performance across the entire asset base. We are back on track. At Horizon, we safely resumed full production in the quarter. We leverage the lessons learned from this event, and are moving forward more disciplined and more effective as an operator. We remain committed to creating value for our shareholders by doing it right together…
Looking ahead to 2012, we target production growth of 17% and including 24% crude oil and NGL growth. This reflects our strong primary heavy and light oil drilling programs. Expansion of our liquid rich Septimus Montney shale gas play, additional pad developments at Primrose and solid performance from Horizon. The 2012 budget reflects our continued commitment to disciplined capital allocation and our defined plan to transition the company toward a longer life, sustainable reserve asset base.
As it turned out, Horizon was fully shut down for safety reasons as it undergoes maintenance from an upgraded fire. Following the maintenance, the company is well positioned to gain in 2012 as Horizon kicks into full production and WTI prices improve. Horizon may reach a production of 500K barrels per day and the fact that it is an oil sands play grants a greater level of certainty to the free cash flow that it generates. Management is now more focused on returns and not just increases to scale. In the past, it was so quick to run into oil sands that it suffered from a shortage of labor.
Consensus estimates for Canadian Natural's EPS forecast that it will decline by 5.1% to $2.24 in FY2011 and then grow by 47.8% and 18.4% in the following two years. Modeling a CAGR of 18.4% for EPS over the next three years and then discounting backward by a WACC of 9% yields a fair value figure of $49.34, implying 35.5% upside.
Penn West has improved its position in its own right. Management boosted the bank revolver while hedging its investments. The company may further sell upward of 6K boe/d production for a liquidity injection of ~$400M. This will help allow for flexibility in its $1.6B - $1.7B capex in 2012. Capital expenditures are estimated to represent more than nine-tenths of cash flow, hence the company's risk. Management guided for exit production in FY2011 to be 174K - 178K boe/d, which represents an 8% sequential improvement.
Consensus estimates for Penn West's EPS forecast that it will spike to $1.54 in FY2011, decline by 52.6% in FY2012, and then grow by 61.6% in FY2013. The volatility of these earnings make it difficult to extrapolate off of, but the fundamentals driving them are strong. For investors who are willing to take on the risk, upside is expected to be strong.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.