Growing costs, coupled with its negative exposure to widening crude quality spreads, are expected to limit the company's ability to generate positive earnings surprises in the current favorable commodity-price environment.As the only owner of carbon-dioxide reserves in Mississippi, Denbury Resources has a significant competitive advantage in acquiring and exploiting mature oil reservoirs in the state. While the potential for reserve additions from the company's existing fields is considerable, we believe the potential for purchasing other mature fields and implementing this technology is also very significant. As a result, tertiary operations remain the company's principal focus and its core assets. We expect Denbury to maintain its double-digit production growth track record over the next few years.
Denbury shares have moved up sharply in recent days, inline largely with the extraordinary trajectory of crude oil. The stock is currently trading close to its 52-week high and is up significantly in the last 12 months, outperforming other exploration and production companies in our universe.
While we have all along been strong fans of Denbury's low-risk crude-levered business model, the stock is increasingly acting as a speculative proxy for the underlying commodity, with limited fundamentals support from here onwards. We have a price target of $32 on the stock.
O'Reilly Driving Into Headwinds
We stick to our Hold rating on O'Reilly Automotive, Inc. (ORLY), due to rising competition, high gas prices as well as the overall economic slowdown. Both the 'do-it-yourself' and professional installer businesses are highly competitive, particularly in the more densely populated areas served by the auto-parts retailer. Also, the recent acquisition of CSK Auto Corp. (CAO) increases the company's California exposure, which may put ORLY at risk of slowing sales.
Although slowing growth in number of miles remains a concern, the company has an excellent growth strategy and exposure to the 'do-it-for-me segment' of auto repair along with a strong balance sheet. O'Reilly Automotive benefits from its dual market strategy, strong distribution network and unparalleled access to auto parts. However, high food and energy prices cause the consumers to defer maintenance of their vehicles, thereby hurting players like O'Reilly Automotive.
The company is valued at 14.9x our 2008 earnings estimate of $1.78. Although the CSK Auto deal is expected to boost O'Reilly's 2009 earnings and save about $100 million in costs from 2010, near-term concerns and macro-economic adversities stop us from being optimistic on the stock. We have a target of $28 on O'Reilly, which is 15.7x our 2008 earnings estimate.
Buy Entergy Corp. on Valuation
Entergy Corp. (ETR) is shifting towards becoming a fundamentally strong electric energy utility with the separation of its nuclear business. Its core business shows strong earnings growth, cash flow generation, favorable regulatory rate hikes, a reasonable valuation and steady recovery from hurricane damage during September 2007.
Entergy New Orleans emerged from Chapter 11 Bankruptcy proceedings. The recent favorable ruling of the Louisiana Public Service Commission regarding storm cost recovery proceedings offsets unfavorable ruling at Entergy Arkansas. Furthermore, the company's share repurchase program continues to boost EPS.
Therefore, we reiterate our Buy recommendation on ETR with a six-month target price of $130.00. Price appreciation to our near-term valuation target, coupled with a quarterly cash dividend of $0.75 per share which appears sustainable and secure represents annualized total return potential of 18.0%.
Playing It Safe with Safeco
Safeco's (SAF) operating earnings of $147.9 million in 1Q08 were down 15.3% year-over-year, primarily due to lower premiums and higher catastrophe losses. However, operating earnings of $1.64 per diluted share were essentially the same as in the year-ago quarter, attributable to fewer average shares outstanding.
The company has implemented cost savings initiatives and programs to boost sales and underwriting profitability, including a market segmentation system, though strong competition in certain markets and products, especially in the auto segment, continue to pressure the company's premium and earnings growth. This trend is expected to continue during 2008.
Safeco recently entered into a definitive agreement to be acquired by Liberty Mutual Group for $68.25 per share. Our six-month price target of $68.25 per share (up from $50.00 per share previously), reflects the current takeover price, which translates to an approximately multiple of 1.80 times (up from 1.25 times) to our estimated book value (at September 30, 2008) of $37.95 per share. This implies a total return of 3.1% (1.8% capital appreciation + an annualized 2.4% dividend yield).
