. Pace has worked as an analyst covering oil and gas exploration and production companies out of
Credit Suisse First Boston's
Houston office since 1998. (He also worked at CSFB from 1991 to 1995.) He has held similar positions with
Morgan Stanley Dean Witter
Industry Outlook and Style
Natural gas prices are expected to remain above average in 2001. This will drive more drilling by the exploration and production companies. Those with the best drilling results will see their stocks rise smartly throughout the year, says Phillip Pace, CSFB's Houston-based E&P analyst.
The expected gas price -- $4 per thousand cubic feet vs. the usual $2 per thousand cubic feet -- is already built into stock valuations, Pace says. Thus, "most of the upside will come from the drill-bit angle," he contends.
And the surest winners on that front, says Pace, are
, a large-cap exploration company that he calls "the leading driller in the industry," and
, a small-cap, low-risk developer with a "massive inventory of natural gas locations." These two companies, he explains, are in a position to drill more wells and thereby create more shareholder value than the average E&P player. (CSFB has an investment banking relationship with Andarko, but not with Mitchell.)
With a $15 billion
market cap, Anadarko is the biggest name in the sector. It is also "the best large-cap company, having the highest internal growth rate," Pace asserts. In his view, Anadarko is "the only large E&P stock that can sustain double-digit volume growth." (Pace forecasts 12% growth in 2001.) The stock currently trades in the high $50s; Pace projects it to reach $84 by year-end 2001. (In the past 12 months, it has been as low as $28 and as high as $75.)
Pace acknowledges that he expects the industry to boost production overall. The production increases he foresees should boost the sector's multiple. (The group now trades at five-and-a-half times cash flow, lower than the historical range of six to eight times.) But Anadarko's multiple -- now six times cash flow, historically seven to 12 -- should continue to stay ahead of the pack, in Pace's view. He expects Anadarko to earn $4.64 a share and to generate $12 a share in cash flow
Mitchell Energy has a $2.5 billion market capitalization but a smaller float, since chairman George Mitchell owns a substantial percentage of the shares. Pace likes the company because it doesn't have to go exploring for hydrocarbons. Its development is all on acreage Mitchell owns. Furthermore, due to some technological advances, Mitchell's development cost has decreased substantially in the past five years, from 90 cents per thousand cubic feet to 50 cents per thousand cubic feet. "That's a great rate of return in a $2 gas price environment, and, assuming the gas price drops from its temporary high of $9 to $3 or $4, the return is even more extraordinary. The beauty of Mitchell's position," he concludes, "is that by owning all the acreage, its production risk is low, which provides a high degree of visibility for the company's growth profile."
Specifically, Pace is counting on Mitchell to grow production at about 20% annually, which compares favorably with an industry average of 7%. (The latter figure is acquisition-dependent, Pace says.) He projects earnings of $4.65 and cash flow of $9.50 in 2001. Near year-end 2000, Pace raised his 12-month target price on Mitchell's stock to $65 - $75; it had surged from $20 to $50 in the previous six months.
Favorite stock for next 12 months:
"Anadarko is the most active driller in the U.S. at a time when natural gas economics are excellent. The shares remain cheap relative to the company's underlying value-creation potential."
Rate Their Stock Picks:
Which stock do you like best?
Morris: EOG Resources