Over the last two years, Newfield Exploration (NYSE:NFX) has shifted its energy exploration and production model from being a natural gas company to almost exclusively drilling for oil. The high value of oil and low current prices for natural gas make this a sensible business shift, but Newfield is lagging some of its competitors in the shift to liquids production and the market seems to still be valuing the stock based on low natural gas prices. Investors should understand where this company is in the business shift and decide if there is some undiscovered value in this stock.
Newfield conducts energy exploration and production activities in the Rocky Mountains, North Dakota Bakken play, the Oklahoma Mid-Continent play and offshore Malaysia and China. The company also owns Gulf of Mexico deep water gas production assets. Current oil production comes primarily from the Rocky Mountains and Malaysia and these areas are the focus of the company's production growth. The company's gas production is focused on the Mid-Continent play.
In 2009, the management of Newfield Exploration made a decision to move away from natural gas exploration and production and focus on crude oil and natural gas liquids - NGLs. At the end of 2009, the company took a non-cash $1.3 billion write down of its energy assets due to the declining price of natural gas. Going into 2010 the company directed 30% of capital expenditures to finding and producing oil. Now in 2012, the company will spend all of its exploration capex on the search for crude oil and NGLs. In a recent earnings conference call, CEO Lee Boothby noted that this is the first time in his 13 years with the company that Newfield Exploration had zero rigs drilling for natural gas.
The shift from natural gas production - and the company still produces a lot of natural gas - to crude oil has resulted in relatively level net income for the company. In 2009, the net income - not including the asset write down and other non-cash items - was $5.12 per share. In 2010 the company earned $3.91 per share. For 2011, revenue rose by 25% to $2.5 billion and reported net income came in at $3.99 per share. By the end of the 2012 first quarter, 47% of Newfield's production was in crude oil or gas liquids with 90% of that amount consisting of crude oil. The company has a goal to increase liquids energy production at a 20% compound annual growth rate. Energy liquids are expected to account for 80% of revenue in 2012, up from 70% in 2011 and 55% in 2010. The produce the 80% of revenue, liquids will be just under half of oil equivalent production. There is not much money to be made in natural gas these days. To fund the capital expenditures required for the growth, the company has sold off some non-core assets, primarily Gulf of Mexico deep water production and some Bakken acreage.
The stock market has not been kind to the share price of Newfield Exploration. The shares are down over 50% over the last 12 months while the shares of large-cap exploration and production company EOG (NYSE:EOG) are down just 5%. When Newfield Exploration's market cap of $4.4 billion is compared to similar sized energy exploration companies, Newfield has generally under-performed its peers. Using the same one-year time frame, Cimarex Energy (NYSE:XEC) is down 32% and Plains Exploration (NYSE:PXP) is up 7%. The Ultra Petroleum (UPL) share price is down similar to Newfield, off 54%. The Newfield Exploration share price has performed worse than Chesapeake Energy (NYSE:CHK) - down 44% - which has pretty much stayed the course with natural gas.
Newfield Exploration currently trades at less than 7 times 2011 earnings. The Wall Street consensus estimate predicts profits will fall by 20% in 2012 to earnings of $3.09 per share. The company should significantly increase crude oil production during the year and if oil prices stay at the current level or higher, the company should be able to beat Wall Street expectations. The actual results from energy exploration and production companies are very dependent on what happens with energy prices. Newfield has hedged the bulk of its 2012 natural gas production, so final results depend on the price of oil and the company's drilling successes. Newfield is a more speculative investment than the larger companies like EOG. The trade-off is exposure to some very different energy finds in the northern Rocky Mountains and off the coast of Asia. Newfield Exploration could be a big, positive surprise. If not in 2012, then next year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.