As always, the folks at XTO Energy (NYSE: XTO ) gave us a lot to think about with their quarterly conference call comments. Assessing whether the natural gas-oriented E&P is executing on its strategic plan, however, is more of a no-brainer.
As we've noted in the past, XTO is a machine that marches. The mechanical marauder advanced daily production by 29% over last year's second quarter, and operating cash flow leaped 41% in the same period. The Barnett Shale, which has also been kind to competitors like Devon Energy (NYSE: DVN ) and EOG Resources (NYSE: EOG ) , continues to bloom. Production popped 50% year over year.
Despite that region's surge, the quarter's standout wells were two huge horizontals over in East Texas. This area, dubbed the Freestone Trend by XTO, averaged more than half a billion cubic feet of daily gas production, slightly edging out the Barnett's contribution.
On a six-month basis, XTO's annualized return on capital employed comes in at 14%, which is off a bit from prior-year highs. Through June, cash margin is running just shy of prior highs, at 63%. I already discussed the sources of margin pressure last quarter, but I think the dip in return on capital is more a reflection of the company's huge recent acquisition activity. XTO can't unlock this value overnight.
That said, the value of XTO's whirlwind purchases is pretty clear. In CEO Bob Simpson's words, these guys "don't do ram pasture leasing." In other words, the company's not just padding its acreage resume. Anticipated 2009 cash flow from the year's $10.6 billion in acquisition commitments totals $2.4 billion, so XTO only paid around 4.4 times cash flow -- which is well-protected by hedges.
Taxes are a recurring theme in E&P mergerland. XTO reinforced industrywide chatter with its comment that "opportunities were largely driven by the fear of tax change in America."
A relatively new theme, also noted by Simpson, is the entrance of oil majors into North American resource plays. Royal Dutch Shell (NYSE: RDS-A ) (NYSE: RDS-B ) is cashing in on a Canadian gas play, while BP (NYSE: BP ) recently followed in the independents' footsteps by snapping up Chesapeake Energy's (NYSE: CHK ) Woodford Shale acreage.
Part of XTO's goal is to avoid hitting a growth wall and becoming takeover bait. With a new plan to double 2007's reserves and production by the end of 2011, I don't see this as a near-term issue.