The price of Brent crude oil has risen by a tenth this past month to $108 a barrel, helping to revive investor sentiment in a sector that suffered serious collateral damage from the harsh spring sell-off in commodities. With market valuations depressed, we've been hunting around for bargains - and we think we've found one in EnQuest (ENQ), the largest UK independent producer of oil and gas in the North Sea by volume.
- Improving sector sentiment
- Rising oil and gas production
- Discount to peers
- Strong balance sheet
- Project execution risk
- Limited exploration catalysts
Launched in 2010 through the merging of North Sea assets held by Lundin Petroleum (Stockholm: LUPE) and Petrofac (PFC), EnQuest represents a relatively low-risk way to play the sector, but still offers considerable upside potential. Not only is the company profitable and boasts a strong balance sheet, but the experienced management team looks capable of delivering impressive production growth that could drive a significant market re-rating in as little as six months.
EnQuest expects to produce between 22,000 and 27,000 barrels of oil-equivalent per day (boepd) from a half dozen mature North Sea fields in 2013, on a par with the 22,800 boepd churned out last year. However, according to brokers, this is set to climb by more than 60 per cent in 2014 to around 36,000 boepd, once the 65 per cent owned Alma/Galia development project comes online. Positively, management reiterated guidance in May that the company remains on track to deliver first oil from Alma in the fourth quarter.
Yet EnQuest's shares still trade 13 per cent below broker RBC Capital's conservative estimate of EnQuest's core asset base - it's producing fields and Alma/Galia - of 143p a share, suggesting the market is only partially pricing in success there. Add in the company's other development projects, such as the exciting Kraken oilfield (for which EnQuest is currently submitting a field development plan to regulators), and RBC's sum-of-the-parts risked net asset value rises to 206p a share.
Should EnQuest successfully get Alma/Galia up and running on schedule, ending the year with an exit rate of around 35,000 boepd, we would expect this discount to disappear and later warrant a premium once sentiment fully recovers or oil prices keep rising. Another boost should come when Kraken receives regulatory approval later in 2013, followed by EnQuest's board sanctioning the project's development.
ENQUEST (ENQ) | ||||
|---|---|---|---|---|
| ORD PRICE: | 127p | MARKET VALUE: | £1.02bn | |
| TOUCH: | 126-127p | 12-MONTH HIGH/LOW: | 146p | 105p |
| FWD DIVIDEND YIELD: | NIL | FWD PE RATIO: | 12 | |
| NET ASSET VALUE: | 161¢* | NET CASH: | $89.9m | |
| Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($m) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|---|
| 2010 | 0.58 | 55.8 | 4.00 | nil |
| 2011 | 0.94 | 363 | 7.60 | nil |
| 2012 | 0.89 | 403 | 46.2 | nil |
| 2013** | 0.93 | 317 | 16.0 | nil |
| 2014** | 1.40 | 582 | 30.0 | nil |
| % change | +51 | +84 | =88 | - |
Normal market size: 20,000 Matched bargain trading Beta: 1.47 £1=$1.53 *Includes intangible assets of $205m, or 26¢ a share **RBC Capital forecasts (note: the large EPS figure in 2012 was mainly attributable to tax adjustments) | ||||
Granted, the resource sector is often plagued by tricky production ramp-ups and inflated costs - so don't take Alma/Galia totally for granted just yet, especially as it is a mature field that is being redeveloped. Snags or delays are of course possible, and RBC's core asset base valuation drops to 120p a share should Alma/Galia face extensive delays. Thankfully, EnQuest pre-drilled six wells there in 2012 ahead of completing them this year and, according to the company, everything is "at or better than prognosis" so far.
Another factor that could explain EnQuest's discount is a lack of forthcoming exploration catalysts. Most of EnQuest's peers have substantial exploration programs alongside oilfield developments, but EnQuest has just one exploration well planned in the second half - in the Sabah area offshore Malaysia. On the flipside, the company saves tens or even hundreds of millions of pounds a year by foregoing expensive, risky drill programs, thereby shoring up the company's treasury. Following a £145m retail bond issue in February, EnQuest has around $200m in cash, along with an unused $900m debt facility. RBC estimates that operating cash flow is likely to pay for the majority of planned capital expenditure this year and next, too, so after moving into debt briefly EnQuest should end 2014 with net cash of $50m.
