Canadian energy explorer Talisman Energy Inc. (TLM) came out with weaker-than-expected first quarter 2011 results, hampered by the imposition of higher taxes on North Sea oil production by the U.K. This was partially offset by surging crude prices.

Alberta-based Talisman – which has changed its reporting currency to U.S. dollars – announced earnings per share from continuing operations (excluding non-operating items) of 15 cents, in line with the year-before quarter but significantly below the Zacks Consensus Estimate of 28 cents. Alberta-based Talisman’s revenue of $2,000.0 million was up 8.9% year over year but could not match up to our estimate of $2,101.0 million.     

Volume Analysis

Total production during the quarter was up 2.1% from the year-ago level to 444 thousand barrels of oil equivalent per day (MBOE/d), reflecting rapidly growing shale volumes and additional volumes from Colombia. Production from continuing operations rose 14.1% from 389 MBOE/d a year ago.

Oil & liquids production during the quarter was down 5.1% to 196,456 barrels per day (Bbl/d), or 44% of total volumes. Volumes were down in North America, Southeast Asia, and North Sea regions, which were partially offset by improved oil & liquids production from other international regions.

Talisman’s natural gas volumes in the quarter were up approximately 8.5% to 1,484 million cubic feet per day (MMcf/d), attributable to increases in North America and Southeast Asia.

Realized Prices

During the quarter, Talisman’s realized commodity prices were up 20.0% from the year-ago quarter to $65.75 per barrel of oil equivalent (BOE), mainly on the back of healthy increases in commodity prices in North Sea and Southeast Asia.

Overall, natural gas prices fell approximately 1.5% year over year to $5.89 per Mcf, while oil & liquids realizations averaged $104.07 per barrel, up 37.6% from the year-ago level.

Cash Flows and Capital Expenditure

Cash flows from continuing operations during the quarter totaled $811 million. Talisman spent $910 million on exploration and development activities.

Balance Sheet

As of March 31, 2011, Talisman had cash and cash equivalents of approximately C$1,327.0 million and long-term debt of C$3,859.0 million (including current portion), with a debt-to-capitalization ratio of 30.0%.

Our Recommendation

Talisman Energy – which has recently signed two transactions with South African petrochemicals group Sasol Ltd. (SSL) to sell its interests in North American shale assets – has repositioned its portfolio for a robust growth profile.

Taking a cautious view of gas prices, Talisman’s capital program this year specifically focuses on the promising North American liquids rich areas in a major shift away from dry natural gas development. The company has taken a vow to keep capex steady at around $4 billion in 2011, while still managing an improvement of around 10% in its oil and gas production.

While subscribing to management’s outlook, we believe the realignment and Talisman’s strategy will take some time to bear results. The company’s exposure to the highly cyclical and capital-intensive E&P sector also remains a key area of concern, in our view. As such, we see the stock performing in line with the broader market and maintain our Neutral rating, supported by a Zacks #3 Rank (short-term Hold rating).

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