That explains why I have been patiently waiting for the investment I recommended in Global Energy Development (GED: 86p) to come good. Clearly, with the shares still 13 per cent adrift of my advised buy in price ('Insiders major buy signal', 17 Dec 2012), I have yet to be rewarded. That said, an announcement from the company yesterday appears to have been missed by investors who were more pre-occupied with a risk-off day in the markets. It is also one that should have a major positive impact on the company’s fortunes, and its share price.
A favourable farm-out deal
The main reason for the share price underperformance has been delays in Global Energy announcing a farm-out deal on a material portion of the company's interest in its Bolívar shale oil properties, located within the Middle Magdalena Valley in Colombia. But we had positive news yesterday when the company finally announced a long awaited farm-out agreement brokered by investment bank Jeffries. The counter party is Everest Hill Energy Group, an affiliated company of the Quasha family trusts which also have an interest in Lyford Investments, Inc., an existing shareholder in Global.
Everest will take a 50 per cent working interest in Global Energy's Bolivar association contract properties in return for making a cash payment of $5m (£3m) to Gloabl Energy to recoup its costs and offering the company a fully carried interest on three wells, comprising re-entry and fracking of two existing wells and completion of one new exploitation well. The first of the two re-entry wells is expected to be spudded within the next six weeks, so we will not have long to wait for further newsflow. Everest has also agreed to drill and complete one new exploitation well in the Contract Area within two years of signing the farm-out agreement.
It makes a lot of sense for Global Energy to agree a farm-out deal because in order to ramp up production and exploit Bolivar's large reserve base, the company needed to significantly increase its drilling activity, which requires substantial technical expertise and manpower to manage this massive shale oil development project. And there is no doubt that the project has potential as the June 2013 report from the US Energy Information Agency (EIA) described the Magdalena Valley of Colombia as a "world class stacked (vertical) shale oil play", prompting Global Energy to make a substantial revision in its development plans which should increase the company's recoverable 3P reserves.
Those comments by the EIA are not without foundation as the La Luna/Northern Middle Magdalena area has been the subject of intense drilling activity by the super majors. High quality operators in the area include ExxonMobil (NYSE: XOM), Royal Dutch Shell (LSE: RDSA), Lewis Energy, YPF, the Argentinean state-owned oil company and Ecopetrol, the Columbian state-owned oil company.
In fact, no fewer than 25 shale wells are scheduled to be drilled in the area over the next two to three years, including 13 by super major ConocoPhillips (COP: NYQ), six each by both ExxonMobil and Royal Dutch Shell, and two by Ecopetrol.
Valuable resources
Global Energy may be a minnow by comparison with these majors, but it has some significant assets to exploit. At the end of 2012, the company's Bolivar reserves consisted of 24.2m barrels (1P-proved), 33m barrels (2P-proved and probable), and 105.7m barrels (3P- proved, probable and possible). Ahead of the Everest farm-out deal, analysts at Equity Development forecast $2bn (£1.25bn) of potential pre-tax profits from Global Energy's 1P Bolivar reserves alone in the financial years between 2014 and 2020, albeit capital expenditure of $460m is needed to get the oil out of the ground and to market.
Based on these assumptions, analysts at the broking house calculated a risked valuation of $98.7m, or 158p a share, on the company's Bolivar properties although the unrisked valuation is eight times larger at $789m. To put that into some perspective, Global Energy’s current price is little over half that risked valuation, highlighting the chronic undervaluation of Global Energy's shares. It is even more extreme once you factor in the earnings and value from the company’s other interests.
The majority of Global Energy's oil production currently comes from its contract areas located within the Llanos Basin of Colombia. The focus here is on maximising production volumes, reducing operating costs and utilising cash flow to develop projects within the Middle Magdalena Valley contract areas (Bocachico and Bolívar Association Contracts). And that is exactly what the company has been doing as it more than trebled pre-tax profits to $4.1m on revenues of $19.7m in the first half of last year.
Global Energy's cash flow performance was equally impressive as the company generated almost $7m of operating cash flow and reduced net debt to $11m from $11.7m at the start of last year, despite spending $8.1m on capital expenditure.
And expect even more good news when Global Energy reports full-year results in a few weeks time. Indeed, following massive upgrades post the interims in September, analyst Andrew McGeary at broking house Northland Capital anticipates the company’s pre-tax profits in 2013 will surge from $2.7m to $7.8m to produce EPS of 13.4c, or 8p. Or, put it another way, we are nailed on to see a bumper set of full-year results in March, not to mention potentially lucrative newsflow from the Bolivar wells being spudded in the coming weeks.
Shares undervalued
Despite this positive backdrop, the shares are only trading on 11 times last year’s likely reported earnings. And the multiple drops even further this year as Northland Capital expects Global Energy's profits to rise to $8.4m in 2014 to produce EPS of 15.8¢, or 9.5p. On that basis, the prospective PE ratio is only nine.
For good measure, the shares are also miserly rated on less than half Northland's risked reserves-based price target of 186p. To put the extent of the undervaluation into some perspective, at the current price, the company is being valued at only £32m, or a huge 37 per cent discount to the last reported net asset value of £50.7m. The undervaluation is even more extreme using the numbers from analyst Conor Fahy at research house Equity Development. He believes that Global Energy's current share price is justified on production from the currently producing Llanos Basin fields alone and takes little account of the potential from Bolivar and Bocachico.
Mr Fahy values the Llanos Bason core business at $49.7m, or 79.5p a share and has a risked valuation of $98.7m, or 158p a share, on the Bolivar properties. The Bocachico heavy oil field has net 1P reserves of 12.3m barrels, net 2P reserves of 49.4m barrels, and 3P reserves of 83.5m barrels, so Mr Fahy’s risked valuation of $40.5m, or 65p a share, doesn’t seem unreasonable on those assets. On this basis, fair value comes out closer to 300p a share.
Target price
In the circumstances, and given the timetable for future newsflow, I am very comfortable reiterating my previous buy recommendation on Global Energy's shares and I still believe that a target price of 140p is not only feasible, but is likely to prove very conservative.
From a technical perspective the chart set-up is encouraging. The shares found major support at the key 80p level which was retested and successfully held earlier this month. The 14-day RSI is not that overbought and a move through a trading band between 98p and 110p would be very positive indeed, opening up a real possibility of an attack on the December 2012 highs around 124p.
Offering 63 per cent upside to what could prove to be a very conservative initial target price of 140p, I continue to rate Global Energy’s shares a buy on a bid offer spread of 85p to 86p ahead of what will be bumper full-year results in a few weeks time and potentially exciting news from the drilling activity shortly after that.
Please note that around 86 per cent of the company's issued share capital is controlled by the top nine shareholders, so Global Energy's shares can be volatile due to the low free float. I have taken this into account in making this recommendation.
Please note that I am currently working my way through a large number of announcements from companies on my watchlist and which I plan to update. These include: LMS Capital (LMS), BP Marsh Partners (BPM), Eros (NYSE: EROS), First Property (FPO), Trading Emissions (TRE), Polo Resources (POL), and Pure Wafer (PUR).
