Monday, March 26, 2018 /6:35 PM /ARM Research
In this report, we look more closely at recent updates and events over the past months, including the FY 2017 result and management call, by Seplat Petroleum Development Company Plc. (Seplat) with a focus on cash flow generation and impact on shareholder’s value, given no change in our views on production, prices, and hedging. Much of the improvement in earnings relative to our earlier forecast stems from improved cash position on the back of an extended debt maturity profile, unrecognized capital allowance, reserve accretion and higher receipt from crude oil lifted in OML 55. Given the foregoing, we see the potential for a strong run up in Seplat’s shares over 2018 as the pieces fall into place.
Consequently, we place a BUY recommendation with an upgraded FVE of N952.81/share (up from N663.85/share). On basis of valuation, Seplat is trading at a 2018 P/E and P/CF of 7.2x and 2.8x relative to African peers of 21.1x and 7.01x respectively. Downside risk to our forecast remains lower oil prices of <$40/bbl. in 2019 relative to our projection of $50/bbl. in the period.
Cash flows on the right path
In the second half of 2017, Seplat concluded a one-year extension of its revolving credit facility (RCF), which was due to expire year-end 2017 – now expires year-end 2018. Furthermore, the RCF has been amended to amortize the outstanding principal balance of $150 million over 5-quarters in equal instalments, commencing Q4 2017. Accordingly, Seplat debt position at year-end 2017 stood at $578 million (2016: $676 million).
Furthermore, in a bid to optimize capital structure and maintain strong free cash flow, Seplat refinanced the RCF worth $300 million RCF due December 2018 with a new four-year $300 million RCF due June 2022 at Libor+6%. Given current debt maturity profile, we expect Seplat to drawdown ~$200 million of the RCF to repay maturing RCF ($120 million) as well as prospect for increased near-term investment in its existing portfolio. Also, Seplat issued $350 million senior notes at 9.25% due 2023 to repay its existing 7-year term facility which has a maturity of ~$145 million in 2018 and 2019 apiece. Given the foregoing, gross debt should print at $550 million in Q1 2018 with free cash flow at $500 million.
Capital Allowance signals carry forward gain
In its financial year 2017 result, Seplat recognized tax credit of $221 million relating to previously unrecognized tax losses in FY 2016 and H1 2017. Specifically, deferred tax assets of $224 million was recognized for these losses, out of which $76 million relates to tax losses of $71 million and $47 million in FY 2016 and H1 2017 respectively. In our view, the balance of $148 million relates to allowances entitled during the pioneer tax period, as during this period, the company was unable to utilize tax allowances, so they were accrued and released when the incentive added.
On this basis, we analyze Seplat’s tax position to grasp the possibility of tax credit going forward. Based on our analysis, we estimate capital allowance of $200 million yearly over the period 2018 -2020. Irrespective, given that the benefit of current and future capital allowances will roll on well beyond 2020 with possibility of additions to the capital allowance, we expect utilization of tax allowance beyond 2019. In our view, the company aims to keep free cash flow positive and thus we think much of the tax allowance will be recognized beyond 2019 wherein we think crude oil prices are likely to trend lower and thus impact Seplat’s earnings.
Consequently, we see little impact of capital allowance on near-term earnings but expect this to support earnings in the long term (2019+).
Production growth supports 2018 stable outlook
Seplat assets saw a 3% increase in 2P reserves to 447.3mboe (226.3mbbl of oil and 1,455.7Bscf of gas), largely from the Sapele shallow field at OML 4 and an increase in gas reserves at OML 53 more than offsetting volumes produced in the year. Also, working interest 2C resources stood at 61mboe (48mbbl of oil and 75Bscf of gas). Consequently, the Company’s working interest 2P+2C reserves and resources stood at 538mboe (274mbbl of oil and 1,530Bscf of gas).
Over 2018, we expect working interest production of 43.3kbopd (+17% YoY) reflecting oil volumes of 24.2kbpd (+35% YoY) and gas volumes marginally up to 114Mscfd. The foregoing alongside, our crude oil price and gas projection of $60/bbl. and $3/Mscf respectively should drive a 40% YoY expansion in revenue to $634 million – oil revenue at $494 million (+50% YoY) and gas revenue at $141 million (+13% YoY). Management noted that it has hedged 3.6mbbls and 3.0mbbls. in H1 and H2 2018 at average strike price of $40/bbl. and $50/bbl. respectively, in a bid to support its cash flow strategy.
Other earnings support is the multiple export terminal expected to de-risk volumes as well as the Assa North-Ohaji South Field Development (ANOH) gas project. The third-party operated Escravos pipeline, which is projected to be fully commissioned and operational in Q3 2018, is expected to provide export option for oil volumes at OMLs 4, 38 and 41. This is expected to reduce downtime and reconciliation losses for the company. That said, we are less sanguine on this and have rolled forward its impact to 2019. On the ANOH gas project at OML 53, management expects this to underpin the next phase of growth for its gas business and expects the project to achieve financial investment decision (FID) in H1 2018.
Valuation is more compelling
We raise our FVE from N663.85/share to N952.81/share after reviewing our model and considering recent updates on the company’s operations, precisely debt restructuring, higher production, and tax position. Our revised target equates to 2018 P/E and P/CF of 7.2x and 2.8x relative to African peers of 21.1x and 7.01x respectively. Downside risk to our forecast remains lower oil prices of <$40/bbl. in 2019 relative to our projection of $50/bbl. in the period. Against this backdrop, we place a BUY rating on the stock.