As a result of last week’s soaring natural gas prices, continued firm oil prices and stable drilling costs, Raymond James & Associates said it is raising its price targets on 22 exploration and production companies that it has labeled Strong Buy and Outperform.
“We believe that the market is now poised to lift valuation multiples of E&P stocks more in line with historical averages,” said Raymond James analyst Jeffrey Mobley. “We are increasing the average target multiple for our group from 5.7x to 6.3x 2004E EBITDA, which raises our targets by approximately 10% and average potential upside to over 20%. Historically, E&P stocks have traded in a range of 5.0x to 7.0x forward EBITDA estimates.”
Mobley noted that gas futures prices are trading near $7/MMBtu and the 12 month strip closed last week at $5.59, near the Raymond James forecast of $5.50/MMBtu for 2004.
“We expect natural gas prices to remain strong through the winter, despite high storage levels as the market continues to price ration declining gas production from the industry. We do not expect the supply picture to change much in 2004, or in fact, in the next several years, which should keep average natural gas prices in a range of $4.50 to $6.50/MMBtu and E&P profits robust.”
Mobley also noted strong crude oil demand in China and a weak U.S. dollar have “forced OPEC to effectively defend a price band above its ‘official’ range.”
Furthermore, despite a 30% drilling increase, oil service costs have only risen 5-15%, fostering “outstanding project rates of return from E&P companies.”
Specific stock target multiples are based on a company’s fundamentals, including prospective growth rate, level of financial leverage, reserve life, asset base quality and other factors.
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