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Thursday, 10/18/2007 6:46:41 PM

Thursday, October 18, 2007 6:46:41 PM

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TXC TXCO --Raising Target Price to $24; Maintaining 2007 Volume Target - Part 1/2






PLEASE SEE END OF NOTE FOR IMPORTANT DISCLOSURES.



TXCO Resources Inc. Analyst: Raymond J. Deacon, CFA

(TXCO - NASDAQ) (303) 436-1113

August 3, 2007 Denver, Colorado





Raising Target Price to $24; Maintaining 2007 Volume Target of 9 Bcfe



TKR/ Price 52-wk EPS (FY-Dec) P/E MCap Target

RTG (8/2) Range 2006A 2007E 2008E 2007E 2008E (mn) Yld Price

------------------------------------------------------------------------------

TXCO / 9.92 15-9 0.21 0.01 0.50 nm 19.8 334 0.0% 24

Outperform





Event

2Q EPS reflect the inclusion of the Output purchase, which brought higher costs

per unit to the income statement. EPS were below our estimates (loss of $0.04

versus our estimated $0.12 profit) principally because of higher-than-expected

DD&A rates and LOE expenses. Absent any guidance, we are carrying the per-unit

costs forward for the remainder of the year. Our EBITDA estimate declines by

roughly 10% for this year although the 2008 estimate rises given higher

expected oil prices and slightly higher volume projections (assumes tar sands

production begins to ramp in December given announced plans to drill more than

a dozen wells by year-end).



Impact

Neutral. Given delay in first Pearsall horizontal well becoming a 4Q story.



Forecasts

2007 EBITDA declines 9% while 2008 EBITDA is increasing 21%, principally due to

an assumed increase in oil revenues to $102 million versus $79 million

previously. We maintain our 2007 and 2008 production forecast of 9.0 bcfe and

11.7 bcfe.



Valuation

Our new $24 a share target price reflects the NAV impact from a higher mid-

cycle price case (2009 and beyond) of $55/bbl for benchmark NYMEX pricing and

$7.50/Mmbtu for natural gas.



Recommendation

We rate the shares OUTPERFORM and believe they offer a highly attractive

risk/reward proposition.





Details & Analysis

Our thesis on TXCO remains that the proven reserves and the Glen Rose Porosity

inventory is worth somewhere between $9 and $10 a share and that investors gain

exposure to the San Miguel tarsands play, the Pearsall Shale play, and the

horizontal Glenrose shoal play on the Output properties essentially for free.

The following table shows our estimate for the value of the company's 300

locations in the Glenrose Porosity play, typical IRRs, and the NPV per well

assuming a $55/bbl oil price.



Exhibit 1: Glenrose Porosity Economics & Inventory



*** Graphic object removed from ascii version of document. ***





Source: BMO Capital Markets Estimates and Company Reports.



Additional conference call and recent Boston/Chicago roadshow highlights:

" Schlumberger has been hired to do a reservoir study on the company's Glen

Rose Porosity play to determine oil in place, and recoverable reserves as well



as to suggest a secondary recovery program for the future. This may result in

play being classified as one reservoir and allow the company to book PUDs

(positive F&D impact). The company is working diligently on ways to lower the

reservoir pressure to allow the oil to escape from the porosity matrix.

" Deep Bossier. Peers are drilling wells in excess of 65 mmcfpd on the same

"shelf" of the Bossier as TXCO in the vicinity of the Fort Trinidad field. We

look for a well to be drilled in 2008.

" Tar Sands. We expected news on pricing of tar sands product from Corpus

Refinery at this point and it looks like that news is further away than we had

thought. By year end we hope to see commercial production from a pilot that may

consist of as many as 32 wells.

" Pearsall. Because of the completion technique equipment that will be

required it is likely two months until results from fracture stimulation are

known. Anadarko recently permitted its first horizontal well to test the

potential of the Eagleford and Pearsall shales in the Maverick basin, having

drilled five vertical wells. The lateral in the well extended 1,560' versus

2,500-4,000' planned lateral since Encana, the operator, had difficulties

handling pressures encountered. TXCO intends to drill its next well

underbalanced to avoid formation damage in, it hopes, to improve deliverability

from the well.

" 3-D defined Glenrose Shoals on Fort Trinidad field have significant

potential. The first of seven planned wells targeting the Glen Rose B is slated

for September. The Glen Rose C shoal had been the primary target given that it

had oil while the Glen Rose B was never targeted for development.

" Capex. We believe that in order to fund expected drilling in the San

Miguel tar sands play the cap-ex will go up.

Company Description

TXCO Resources is a small-cap ($365 million) independent oil and gas E&P

company. The company's core area is the Maverick Basin (85% average working

interest) in Southwest Texas, with more than 600,000 acres in the basin. TXCO

also has interests in the Marfa Basin in West Texas. The company reported year-

end 2006 reserves of 41.4 Bcfe, 48% of which are proved developed. On a pro

forma basis for the merger, the company has 81.4 bcfe, and production of

roughly 21.4 mmcfepd and net acreage of more than 723,000 acres. With the

acquisition now closed, the company has in excess of $90 million available for

development capital expenditures on its credit lines. The company also owns a

91-mile pipeline system in the Maverick basin with current capacity of 35

mmcfpd (33% utilized) with expansion potential to 100 mmcfpd.



Exhibit 1: TXCO Actuals and Estimates



*** Graphic object removed from ascii version of document. ***





Source: BMO Capital Markets Estimates and Company Reports.



Exhibit 2: TXCO Summary Balance Sheet and Reserve Table



*** Graphic object removed from ascii version of document. ***





Source: BMO Capital Markets Estimates and Company Reports.



Exhibit 3: TXCO NAV Model



*** Graphic object removed from ascii version of document. ***





Source: BMO Capital Markets Estimates and Company Reports.





Important Disclosures

Analyst's Certification

I, Raymond J. Deacon, CFA, hereby certify that the views expressed in this

report accurately reflect my personal views about the subject securities or

issuers. I also certify that no part of my compensation was, is, or will be,

directly or indirectly, related to the specific recommendations or views

expressed in this report.

Analysts who prepared this report are compensated based upon (among other

factors) the overall profitability of BMO Capital Markets Corp, BMO Nesbitt

Burns, and their affiliates, which includes the overall profitability of

investment banking services. Compensation for research is based on

effectiveness in generating new ideas and convincing clients to act on them,

performance of recommendations, accuracy of earnings estimates, and service to

clients.

Company Specific Disclosure

BMO Capital Markets Corp. has provided advice for a fee with respect to this

company within the past 12 months: Yes

BMO Capital Markets Corp. has undertaken an underwriting liability with respect

to this company within the past 12 months: Yes

BMO Capital Markets Corp. has provided investment banking services with respect

to the company within the past 12 months: Yes

BMO Capital Markets Corp. or its affiliates owns 1% or more of any class of

common equity securities of the company: No

BMO Capital Markets Corp. or its affiliates makes a market in the security:

Yes

BMO Capital Markets Corp. or its affiliates managed or co-managed a public

offering of securities of the company in the past 12 months: No

BMO Capital Markets Corp. or its affiliates received compensation for

investment banking services from the company in the past 12 months: No

BMO Capital Markets Corp. or its affiliates or its officers own warrants or

options: No

Company is a client (or was a client) of BMO Capital Markets Corp. or an

affiliate within the past 12 months: Yes, for investment banking services

Employee, officer, or director of BMO Capital Markets Corp. is a member of the

Board of Directors or an advisor or officer of this company: No

A member of the Board of Directors of Bank of Montreal is also a member of the

Board of Directors or is an officer of this company: No

Analyst and/or associate who prepared this report is a member of the Board of

Directors of this company or an advisor or officer of this company: No

A household member of the research analyst and/or associate who prepared this

report is a member of the Board of Directors of this company or an advisor or

officer of this company: No

Analyst or associate who prepared this report or member of household of analyst

or associate owns shares: No

Analyst or associate who prepared this report or member of household of analyst

or associate owns warrants/options: No

BMO Capital Markets Corp. or its affiliates expects to receive or intends to

seek compensation for investment banking services from the company in the next

three months: No

Analyst received compensation from the company in the past year: No

BMO Capital Markets Corp. or its affiliates received compensation for products

or services other than Investment Banking Services from the company in the past

12 months: No

Methodology and Risks to Our Price Target

Methodology: Price target is based on our NAV, which assumes mid-cycle

commodity prices of $7/MMBtu and $50/Bbl.

Risks: Commodity prices, ability to create predictable growth from the Glen

Rose.

Breakdown of Rating Distribution and Banking Clients



(Continued in Part 2 ...)

Thomson Financial

All rights reserved. 800.347.7822

B/GT C/CNA C/CUS I/NOI S/SEO TXCO TXCO.O




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