Noble Energy Looks Great, But Is The Valuation Too Filling?

By Stephen D. Simpson, CFA | July 11, 2013 AAA

In what has been an extremely iffy year for the E&P sector, Noble Energy (NYSE:NBL) is an outlier in many respects. Not only has the stock done quite well over the past year, but that's even with a gas-heavy reserve base and exposure to the Gulf of Mexico – two things that the market has really soured on in general.

Clearly this is a situation where digging a little deeper is warranted. Noble Energy is doing so well in part because of its very successful drilling program in northern Colorado, it's large gas discoveries off the coast of Israel, and a very compelling outlook for debt-adjusted production growth over the next three to five years. Honestly, the question today doesn't seem to be so much about whether Noble is a top-notch emerging mid-tier energy company, but rather what to pay for all of that.

SEE: Oil And Gas Industry Primer

Oil And Gas, In The Right Places
Noble is still on the smaller side of the “large independent E&P” space, with its 1.2 billion (oil-equivalent) barrels of reserves putting it well behind the likes of Apache (NYSE:APA), Chesapeake (NYSE:CHK), Anadarko (NYSE:APC), and EOG (NYSE:EOG). What's more, it's a gassy company with a lot of development work still to do – about 70% of the booked reserves are natural gas and only about 40% are developed.

But I'm going to argue that this is a case where the numbers don't necessarily tell the full story, or at least not without more digging.

A large chunk of those reserves (nearly 30%) are in the Wattenberg part of the DJ Basin (Colorado), and this has already been shown to be a very high-quality oil formation. Not only has Noble seen good results here so far, it appears as though the resource potential for Noble's acreage could be six times the booked reserves figure (or 2.1B barrels BOE).

Noble has also made major discoveries off the coast of Israel, where it has nearly 400M barrels BOE (or 2.2Tcf) of natural gas reserves across multiple fields. Although U.S. natural gas is none too popular today because of its low price, these fields can send gas to the much higher-value markets of Europe and Asia, and a recent decision by the Israeli government will allow Noble and its partners to export up to 40% of the gas they produce from these fields.

SEE: A Guide To Investing In Oil Markets

Cash Flow Coming, And It Will Be Reinvested At Least In Part In Growth
Between the Wattenberg properties and the Israeli gas fields, Noble is looking at some major production and cash flow growth in the coming years. At least some of this is likely to be reinvested in the business. Noble has exploratory assets in areas like the Faulklands and Western Africa that are worth drilling and should further expand the company's reserve base. What's more, I believe further development and exploration around existing properties in Colorado and Israel is likely to significantly grow the reserve base over the coming years.

A Smart Player
It's not just Noble's reserves and debt-adjusted growth potential that appeal to me. I also like how management structures the company with respect to risk and return maximization.

The company's Wattenberg resources require more expensive drilling procedures (fracking and so on), but experience has generally shown that you get what you pay for – skimping on stages or proppant hurts overall returns. So here is a case where they need to spend money to make money.

On the other hand, the company has de-risked both its Israel and Marcellus assets. Through its Marcellus joint venture with CONSOL (NYSE:CNX), Noble's obligation to help pay for drilling (the “carry payments”) are suspended when natural gas prices are below $4. In Israel, Noble has sold part of its interest to Woodside to not only reduce its capital commitment and diversify risk, but also bring in a company with significant experience in the natural gas world.

The Bottom Line
The only hang-up for me with Noble is what the proper multiple to pay may be. Noble clearly trades at an EV/EBTIDA premium to its comp group, which seems reasonable given its above-average growth potential. Still, it's a question of degree – if Apache is trading below 4x its forward EBITDA and Anadarko and EOG around 5x, what's the right number for Noble? Based on the history of the sector, I'd say 6.5x is about as far as it should go (which suggests a $67 fair value), but then Noble is clearly on the very high end of “above average” in terms of its prospects.

In any case, I would point out that investors may also want to check out high-quality names like Apache, Anadarko, EOG, and Whiting (NYSE:WLL) alongside Noble (with the second and fourth names also exposed to the Wattenberg). I do like Noble and I suspect this could be a case where loosening up on price/value discipline could pay off, but perhaps the shares need to cool off a bit first.

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