Powering Up

The company has an excellent track record for dividends – it paid in 2008 a dividend corresponding to a dividend yield of almost 7 percent. Offhand, we see no risk that Shell will have to reduce its dividend yield considerably over the coming years. We expect that the company’s new CFO will take a critical look at the organizational structure and initiate savings and rationalization plans to reduce costs to the sector level.

The company has a well-diversified business model – geographically as well as in terms of products. In addition, the company is present in all links in the value chain.

Carl Kirst, CFA
BMO Capital Markets Corp.
713-546-9756
[email protected]

While correlations remain in the below-historical 50 percent range, natural gas liquid (or NGL) prices are still on the rise, and frac-spreads (the margin between NGL and natural gas prices) have climbed back to well above 10-year averages, and should continue to strengthen in 2010. Companies with exposure to NGLs and/or widening frac-spread, include Williams Companies, Southern Union, Spectra Energy, Oneok, Questar, Fort Chicago Energy (units), and Inter Pipeline (of Canada).

Questar (STR): Our top commodity-levered stock remains Questar ($47, Outperform). We believe its mix of 60 percent to 75 percent hedged position through 2010, high return Pinedale and Haynesville asset base (of which we now include $7/share of non-conventional value), discounted E&P reserves (implied E&P valuation is $1.59/Mcfe of proved and 4.5x EBITDA, a 40 percent discount on both counts to the BMO large/mid-cap E&P universe average) makes a compelling valuation story even with gas prices coming under pressure.

Our net earnings outlook was recently reaffirmed (and above guidance); the company showed further progress in the Haynesville (another top well, lower drilling costs and more acreage), improving Rockies basis (from ~$1.25 discount in June to only ~$0.50 in July), and it expects a horizontal test in the Granite Wash by year end (potentially putting it in another high-profile play).

We like the fundamental foundation of STR, particularly for a stock whose implied E&P value is trading at under half the average E&P on a unit reserve basis, and below that of its pipeline peers. In short, we think investors should take advantage of any weakness at current levels.

We’ll keep the earnings overview to the clean headline of $0.54, on target with consensus … After several hours of model tweaking, analysis, et. al., we came away with an earnings outlook unchanged – continuing our belief that management guidance is conservative – and that the fundamentals continue to support owning this name at its current valuation.