When it comes to oil & gasthere are several exceptionally undervalued companies. BP (BP) is exceptionally cheap while offering far greater safety than what the market acknowledges. Another great company is Occidental Petroleum (OXY). In this article, I will run you through an operating cash flow model on Oxy and then triangulate the result against a review of the fundamentals of BP and Talisman Energy (TLM).
First, let's begin with an assumption about the top-line. Oxy generated $24.1B in revenue in FY2011, which represented a 25.9% gain off of the preceding year. I model an 8.4% per annum growth rate over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses and taxes. I model cost of goods sold as 32% of revenue versus 10% for SG&A and 1.4% for R&D. Taxes are estimated at 41% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.) Contrary to media and political depictions, American oil & gas companies are amongst the highest taxed entities in the world.
We then need to subtract out net increases in working capital to get operating cash flow. I estimate this figure hovering around -5% of revenue over the explicitly projected time period.
As it turns out, Oxy is trading at just 5.7x my 2012 operating cash flow estimate. If it continues to trade at this low multiple, by 2017 it will be trading north of $100B by 2017 for around 56% upside.
All of this falls within the context of operational challenges:
Net income was $1.6 billion or $1.92 per diluted share in the first quarter of 2012 compared to $1.5 billion or $1.90 per diluted share in the first quarter of 2011. Several factors lowered earnings during the first quarter by about $0.05 per diluted share. These factors included higher insurgent activity in Colombia, resulting in pipeline interruptions; a maintenance-related shutdown in Qatar; field shut-in due to labor disputes, which have shut down the pipeline in Yemen; and inclement weather at our Elk Hills operations, partially offset by additional oil entitlements in Libya related to the initial start-up phase of operations after the 2011 civil unrest.
From a multiples perspective, however, Oxy remains cheap. It trades at a respective 9.5x and 8.7x past and forward earnings versus 32.8x and 9x for Talisman and 4.9x and 5.7x for BP.
Consensus estimates forecast Talisman's EPS growing by 52.6% to $0.87 in 2012 and then by 24.1% and 40.7% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $1.03, the stock will hit $13.39 for 35.9% upside. With a beta of 1.46 and a relatively low dividend yield of 2.6%, Talisman carries greater risk than BP and Oxy. This implies, however, it will be quicker to recover lost shareholder value when the economy hits full employment.
Consensus estimates forecast BP's EPS declining by 16.2% to $6.35 in 2012, growing by 1.7% in 2013, and then declining by 7% in 2014. This has set the bar incredibly low for high risk-adjusted returns. Assuming a multiple of just 9x and a conservative 2013 EPS of $6.39, the stock will hit $57.51 for an incredible 55% upside. This is already on top of an exceptional dividend yield of 5.2%. Given how strong the risk/reward is for BP, I expect to see it rank amongst the strongest performers over the next few years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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