Global Energy's share price has yet to fulfil the promise I envisaged when I highlighted the investment case, but I still believe maintaining a patient stance is warranted. Chairman Michael Faulkner is clearly optimistic of the upside potential in his company as he invested a further £20,000 of his own money purchasing shares at 100p each seven weeks ago. His holding of 370,000 shares represents 1.02 per cent of the issued share capital, so is not insignificant either.
The key reason for the share price underperformance is due to delays in Global Energy announcing a farm-out deal on a major portion of the company's interest in its Bolívar shale oil properties, located within the Middle Magdalena Valley in Colombia.
Farm-out to highlight hidden value
The importance of a farm-out deal should not be underestimated because in order to ramp up production and exploit Bolivar's large reserve base, the company needs to significantly boost drilling activity, which will require additional technical expertise and manpower to manage this massive shale oil development project. That's why Global Energy's board have been working together with investment bank Jefferies to find a farm-out partner.
Admittedly, given the nature of farm-out deals, there are invariably delays and closure is more often than not put back. But I am more than hopeful of a successful conclusion of the company's strategic partnering efforts in the next couple of months, if not sooner. It's not as if there is a lack of cash-rich partners to strike a deal with either in this particular part of the world. 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, by my reckoning, 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. It's inconceivable that one of these majors would not be interested in Global Energy's Bolívar properties which are located within the premier area of the Middle Magdalena Shale Oil play.
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). Bearing this in mind, there were no fewer than three farm-outs last year, and there has been a further one this year, involving ConocoPhillips, ExxonMobil and Royal Dutch Shell. Moreover, with analysts at Equity Development forecasting $2bn (£1.25bn) of potential pre-tax profits from Global Energy's 1P Bolivar reserves in the financial years between 2014 and 2020, there is an enticing carrot on offer. True, capital expenditure of around $460m is required to get the oil out of the ground and to market, but there is clearly value to be realised by all parties in a farm-out deal. Equity Development calculate 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.
In my opinion, any disposal or farm-out deal will not only bring into focus the chronic undervaluation of Global Energy's shares, but also the bargain basement valuation being attributed to the rest of the business, even though these operations generate substantial profits.
Value in the rest of the business
To recap, a majority of Global Energy's oil production currently comes from its contract areas located within the Llanos Basin of Colombia, South America. 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).
It's therefore worth noting that Global Energy more than trebled pre-tax profits to $4.1m on revenues of $19.7m in its half-year results released in mid-September, albeit earnings in the prior half year were depressed. Importantly, cash flow was robust, as the company generated almost $7m of operating cash flow and ended the six-month period with $11m of net borrowings, down from $11.7m at the start of the year, despite spending $8.15m on capital expenditure. In other words, Global Energy is in a good bargaining position to realise full value from its assets given the company's debt to equity ratio was only 13 per cent at the June half-year end.
Earnings upgrades
The lack of progress in Global Energy's share price also fails to acknowledge the steep earnings upgrades that have been coming through. For instance, analyst Andrew McGeary at broking house Northland Capital massively upgraded his full-year forecasts post the interims in September. In the absence of the one-off issues that impacted profits in 2012, Mr McGeary was anticipating full-year pre-tax profits to rise sharply from $2.7m to $6.2m. But, with Global Energy reporting profits of $4.2m for the first half alone, Mr McGeary now expects full-year pre-tax profits to almost treble to $7.8m. Moreover, that's after factoring in a $2.3m hit from the low oil price. Or, put it another way, we are nailed on to see a bumper set of full-year results in March, not to mention potentially a lucrative farm-out deal, too.
And it's not as if the good news is in the price as, based on Northland's 2013 EPS estimate of 13.4¢, or 8.3p a share, the forward PE ratio is only 10.5. The earnings multiple drops even further next year as the broking house anticipates Global Energy posting profits of $8.4m and EPS of 15.8¢, or almost 10p a share. On that basis, the prospective PE ratio falls to nine in 2014.
For good measure, the shares are also priced a third less than book value of 136p a share and are rated on 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 £33m, or £17m less than net asset value of £50.3m. That looks anomalous to me and I would agree with the comments of Mr McGeary who "awaits further news as to the farm-out/appraisal of Bocachico and Bolivar, respectively, that could provide transformational catalysts (to the share price). Meanwhile, a welcome return to robust profitability should allow shares to appreciate from current low levels".
He is not alone in this view as resource analyst Conor Fahy at research house Equity Development believes that "Global Energy's current share price appears to be justified on production from the currently producing Llanos Basin fields alone. At the very least, it seems to take little account of the potential from Bolivar and Bocachico….. we have been very conservative in our consideration of potential value, which we estimate at 302p a share, still three times the present share price."
To arrive at this figure, Equity Development value the Llanos Bason core business at $49.7m, or 79.5p a share and, as I have previously noted, have 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. This goes a long way in justifying a risked valuation of $40.5m, or 65p a share, on those assets.
Big potential gains to target price
In the circumstances, I am 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 could prove very conservative if the right farm-out deal is struck.
Please note that major shareholder HKN Inc now controls 34.51 per cent of the issued share capital and, along with parties acting in concert, is interested in over 22m of Global Energy's issued share capital of 36.2m shares, representing over 61 per cent of the shares in issue. This also means 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 factor into account when making this recommendation.
Offering 55 per cent upside to my conservative target price, I continue to rate Global Energy shares a decent value buy ahead of the company's long-awaited farm-out deal.
Finally, and in response to recent news flow, I am currently working my way through a number of updates on my following recommendations: Eurovestech (EVT), Heritage Oil (HOIL), Bezant Resources (BZT), Entertainment One (ETO), Marwyn Value Investors (MVI), Amino Technologies (AMO), Eros (NYSE: EROS).
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In the past week I have published five other articles in the past fortnight on the following five companies:
■ 32Red ('Hitting the jackpot', 11 Nov 2013)
■ Macau Property opportunities ('Hot property plays', 12 Nov 2013)
■ First Property ('Hot property plays', 12 Nov 2013)
■ Inland ('Bargain shares updates', 12 Nov 2013)
■ Terrace Hill ('Bargain shares updates', 12 Nov 2013)
■ LMS Capital ('LMS worth capitalising on', 18 Nov 2013)
■ Trifast ('A bolt-on purchase', 18 November 2013)
