TSX Commentary

Veritas Report – Talisman (TLM) – A shale elephant through the eye of a Needle
Although Talisman may appear cheap at 4.3x consensus 2010 cash flows, it is the highest multiple to forward cash flows that the company has traded at over the last five years. While other S&P/TSX 60 energy producers trade at an average of 6.5x consensus 2010 cash flows, these peers hold tax advantages, long life oil sands projects, and/or refining capacity. With rapidly declining offshore production and a foray into shale gas, Talisman is different enough from its peers that a simple multiple comparison is not adequate to explain the company’s value. Talisman is in the midst of a transition that could see an increasing proportion of its production coming from gas, going from 48% in 2008 to 58% by 2012. Over the coming years, the company will progressively shift away from its traditional strongholds in the United Kingdom and North America, to grow its operations in Norway, Southeast Asia, and North American shale gas. Since incremental volumes from Norway and Southeast Asia are not sufficient to maintain overall production, investors are looking to Talisman’s shale gas plays to lead the growth. However, Veritas foresees that factors largely outside of management’s control – such as weak natural gas prices, limited development resources, and suboptimal acreage – will limit the pace of Talisman’s ramp up at its shale plays. While investors wait for Talisman to achieve critical mass in its shale plays, the company’s volumes and cash flows from conventional production are declining. Veritas believes Talisman will be unable to ramp up its shale plays as quickly as Barnett. Veritas’ intrinsic value estimate of C$17 per share, based on US$80 oil and US$6 gas, assumes a more modest expansion of 200 net wells per year beyond 2011. Without anticipating higher commodity prices, Veritas has difficulty finding reasons to hold Talisman’s shares.