Tuesday, November 07, 2017 12:56PM /ARM Research
Our deductions from Seplat Petroleum Development Company Plc. (Seplat’s) latest financial report as well as recent discussions with management underpins our view on the stock’s capacity to close the valuation gap vis-à-vis peers. Although in the near term, aside from pricing in higher crude oil prices, we maintain our stable outlook for the stock, our optimistic outlook for 2018 is reinforced.
In line with this adjustment, comes the prospect for Seplat to relatively outperform its larger peers. Seplat trades at a 2018 P/CF of 1.7x compared to African peers’ and FTSE 350 Oil & Gas index of 5.5x and 12.05x respectively.
Investment Case. Seplat is well-positioned to return to profitability by FY 17 with a sturdy footing for substantial upside in earnings in 2018F. Balance sheet deleveraging and an improving and more stable P&L premised on the company’s return to past production levels and de-risked earnings via adding a new export route to existing two routes) should give investors comfort on earnings performance over 2018.
With capex also decelerating from peak levels attained between 2014-16, free cash flow is set to expand in 2018+, particularly as management guides to implementing capex plans with the primary aim of maximizing current assets. Therefore, we expect Seplat to resume returning cash to shareholders with dividend projected to grow in line with productive capacity.
Key catalyst. Near term catalysts for Seplat includes its operated $1.3bilion ANOH gas and condensate project for which a final investment decision (FID) remains in place for YE 2017 as well as the planned completion of the Escravos pipeline which offers a third export route for the company.
However, crude oil prices below $40/bbl. and a reappearance of insecurity in the Niger delta may trigger a downward review to earnings. That said, we have taken a conservative approach based on the downside risk to our forecast.
Debate on pioneer status. Although Seplat has taken a conservative approach by providing for taxes despite its ongoing deliberation for pioneer tax status, we hold the view that the company is likely to call its tax allowance on capex made during the pioneer tax period, which we estimate at $98 million.
Valuation is more compelling. We raise our FVE from N518.74 to N588.11 after reviewing our model and considering recent updates on the company’s operations, precisely its Escravos project and tax position. Our revised target equates to 2018 P/E and P/CF of 7.0x and 1.7x compared with African peers’ (12.76x and 5.46x) and the FTSE350 Oil & Gas index (22.41x and 12.05x). Against this backdrop, we place an OVERWEIGHT rating on the stock.
Earnings rebound in Q3 17. Reflecting higher oil exports, Seplat delivered solid Q3 results. The result showed a marked rebound in performance with the company posting profit after tax (PAT) of $22.3 million, after six consecutive quarters of losses.
Relative to the prior quarter (Q2 17), oil export was higher almost double-fold to $115 million underpinned by higher production of 26.4kbpd while gas sales remained resilient posting $31.5 million (+7.5% QoQ) with gross production hitting a peak gross daily output of 352Mscfd (working interest: 111Mscfd).
Irrespective, Seplat posted loss after tax of $5.3 million over the nine-months of 2017(9M 16: $97.8 million loss after tax). That said, Seplat’s balance sheet remained sturdy on the back of improved cash flow with operating cash flow at $167 million, free cash flow at $120 million and net debt at $402 million (free cash flow to net debt at 30%).
Revision to FY 17 volumes guides lower earnings. Third quarter working interest production of 44.8kbopd is in line with management guidance of H2 working interest production of 43–50kbopd (Oil: 25–29kbpd, Gas: 110 –130Mscfd), which implies expected FY 17 volumes of 35–38kbopd (Oil: 17–19kbpd, Gas: 105–115Mscfd).
On this basis, we revise our FY 17 volumes lower from 39.3kbopd to 37.5kbopd (Oil: 18kbpd, Gas: 118Mscfd), though we see scope for higher volumes in Q4 17. Consequently, FY 17 PAT should print at $19.4 million compared to loss after tax of $166 million in FY 16
Upbeat outlook in 2018 but risk persist. Starting off in 2018, we expect the company’s exports to rise largely reflecting the planned completion of the Escravos pipeline which offers a third export route for the company. Management has indicated that it is working with the FG to complete the Escravos pipeline where it expects to export circa. 160kbpd.
Though Seplat expects the new pipeline to be operational in Q1 18, we are less sanguine about the target completion date owing to the government’s delayed completion on similar projects, and therefore see H2 2018 as a more realistic date for the project. The combination of an upgrade at the Warri refinery as well as fully operational Trans-Forcados and Escravos pipelines drive our forecast of a 90-day downtime in 2018 with working interest production forecast of 45.5bopd and over four-fold increase in PAT to $108.6 million.
Farther out (2019-2022F), Seplat’s intention to make the Escravos pipeline its primary route guides to lower reconciliation cost. However, we have lowered our crude oil price assumption to $30/bbl. over the forecast period. On balance, we forecast an average working interest production of 50kbopd and mean PAT of $95million over our forecast period.
We estimate cash flow of nearly $278 million in 2018, well above capital spending ($20 million capex plans in H2 2017). With the significant deleveraging in the balance sheet based on our estimates there is clear capacity for enhanced shareholder return via resumption of dividend payments in 2018.