Institutional investors seem to approach energy stocks with the same sort of discipline and dedication that teenaged girls show towards boy bands and pop stars. Whatever was popular last year isn't going to be hot this year, but there's not always a lot of logic in the process. Talisman Energy (NYSE:TLM) does have real challenges that merit a discount, but it seems as though the Street has gone a little overboard here and patient investors may want to consider the name.
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A Cold Wind from the North Sea
A fair bit of Talisman's problems stem from the North Sea, where the company has had some substantial execution issues and setbacks. These issues have not only cost the company money, but have also led to a lower production growth outlook for 2012, diminished confidence in management and significantly less belief in the idea that Talisman can harvest reliable cash flow from these operations and use them to fund growth-oriented projects in U.S. shales, Southeast Asia and the Kurdistan region of Iraq.
As it happens, these difficulties (and the overall challenges that energy companies are facing with funding their growth projects) have led management to contemplate selling as much as half of its interests in those North Sea properties. Geographical proximity would make ConocoPhillips (NYSE:COP), BHP Billiton (NYSE:BHP), Royal Dutch Shell (NYSE:RDS.A, RDS.B), Statoil (NYSE:STO) and Apache (NYSE:APA) at least potentially interested parties. Given Talisman's problems, that could make a tie-up with Apache or Statoil especially appealing, as they have expertise in difficult environments or projects and could perhaps restore some stability to the outlook here.
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Even outside of the company's North Sea struggles, it seems as though Talisman gets little credit for its other operations. While the company had once made much of its potential growth in unconventional gas, management has also seen to the liquids side of the business; production is still fairly close to 50/50 and the company has a path to double-digit liquids growth over the next three to five years.
Eagle Ford has been a pretty promising area for Talisman, but the company scarcely gets the sort of credit for it that others like Cabot (NYSE:COG) and EOG (NYSE:EOG) have received. Likewise, while I could understand some discounts for political risk tied to the company's operations in Colombia, Vietnam, Papua New Guinea and Kurdistan, the implied discounts seem well in excess of the production growth and return potential.
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Slim Down or Push on?
To go back to the point I made in the open, investors vacillate between favoring focused "pure play" exploration and production companies and those with broad international footprints. Right now, the diversified companies like Apache, Statoil and Talisman are out of favor.
The question, though, is how much management ought to accommodate the whims of the Street. Finding a partner in the North Sea certainly makes sense, and it's not hard to argue for selling it outright. Likewise, there are non-core assets like the company's operations in Peru that may be worth more to someone else.
But when it comes to operations in areas like Colombia, Kurdistan, Vietnam and the unconventional shales of America, Talisman is probably better-served sticking to its guns. Certainly the company needs to carefully steward its capital resources (especially with oil prices falling), but an aggressive divestiture program at a time when valuations are so low would do little to help shareholders for the long term.
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The Bottom Line
By almost any reasonable fundamental standard, Talisman shares seem too cheap. If the company merits an average forward EBITDA multiple (on par with Apache), fair value lies around $15.50. Even if investors believe that Talisman should be punished for its execution issues, production growth and finding and development cost prospects, it's still not hard at all to produce a target above $13 per share. Although owning any energy company in a period of falling prices (and falling confidence) is a dicey proposition, Talisman looks like a name where there's more than meets the eye for patient investors.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.