You can't often buy shares in an established North Sea oil producer valued at just over a third of the sector average, where oil production is forecast to double this year and rise by half again the year after.
- Doubling oil production in 2013
- Major chart support
- Strong cash-flow generation
- Cheap valuation
- Large debt pile
- Oil price weakness
- Project development risk
Yet such is the case with Ithaca Energy (IAE), whose share price slumped to a three-year low last week but has since bounced off a major support level around 100p. This is very significant because each time the shares have previously touched this level - in June last year, October 2011 and August 2010 - Ithaca's share price rallied strongly to produce double-digit gains. Moreover, the 14-day relative strength indicator (RSI) - a momentum oscillator - is now in deeply oversold territory and at a depressed level which coincided with the start of the three aforementioned rallies. Another multi-week rally looks imminent.
There are two main factors behind recent share price weakness. First, Ithaca acquired its North Sea oil peer Valiant Petroleum in April for approximately £304m in cash, shares and assumed debt. That has stretched Ithaca's balance sheet and left little room for error at its all-important Greater Stella Area (GSA) field development in the North Sea, where first hydrocarbon production is anticipated in mid-2014. Second, the price of Brent crude oil has slid almost 20 per cent over the past few months.
But we think the market has placed too much emphasis on the short-term impacts of these two events, while dramatically overlooking the underlying merits of the tie-up with Valiant. True, Ithaca is paying a high price based on proven and probable (2P reserves) - $24.3 a barrel. That's above the typical range of between $10 and $20 a barrel for North Sea assets. But if you strip out nearly $500m (£325m) of UK tax allowances, the price falls to $11.1 a barrel. And cash flow from Valiant's low-cost operating fields means the deal should pay for itself in less than two and a half years.
ITHACA ENERGY (IAE) | ||||
|---|---|---|---|---|
| ORD PRICE: | 106p | MARKET VALUE: | £336m | |
| TOUCH: | 105-106p | 12-MONTH HIGH: | 182p | LOW: 91p |
| DIVIDEND YIELD: | nil | PE RATIO: | 1.4 | |
| NET ASSET VALUE: | 193¢ | NET CASH: | $10.6m | |
| Year to 31 Dec | Turnover ($m) | Pre-tax profit ($m) | Earnings per share (¢) | Dividend per share (p) |
|---|---|---|---|---|
| 2010 | 132 | 38 | 27.0 | nil |
| 2011 | 129 | 37.1 | 14.0 | nil |
| 2012 | 170 | 29.2 | 36.0 | nil |
| 2013* | 556 | 210 | 66.0 | nil |
| 2014* | 758 | 359 | 113 | nil |
| % change | +36 | +71 | +71 | - |
Normal market size: 3,000 Matched bargain trading Beta: 1.76 £1=$1.54 *Westhouse Securities forecasts, underlying EPS and PBT not comparable with prior periods | ||||
As for the stretched balance sheet, broker Westhouse Securities estimates the combined group will churn out an impressive $392m in operating cash flow in 2013, rising to $576m next year. This will admittedly go towards the expensive GSA field development, which, along with $350m in cash outflows from the Valiant transaction, will take Ithaca's net debt to $423m by the end of 2013. But should GSA be successfully developed on time, the debt pile will be largely eradicated by end-2014, when Westhouse estimates net debt will fall to a paltry $57m.
As long as the price of Brent crude doesn't fall below $70 a barrel, Ithaca should be fully funded for its entire work programme, too, based on predicted cash flow and existing debt facilities. But to mitigate some of the oil price risk, Ithaca has wisely decided to hedge around a quarter of its expected 2013-14 production at an average price of $106 a barrel (slightly above the current price of $103 a barrel).
