Energean's long-awaited promise emerges

The gas-focused exploration and production company, which is listed in both London and Tel Aviv, is expected to double revenue this year and post over $1bn (£764mn) in pre-tax profit in 2023 – according to consensus analyst forecasts – as the business looks set to hit first production from its flagship Karish project later in 2022.

Even after a good run in the shares since their 2018 listing, investors could be underappreciating the long-term cash flows from the business.

Israel remains key

Israel is the key to Energean’s growth story. The country's rising demand for natural gas underpins the company’s production hopes in the region. Spiking electricity demand, driven by factors such as population growth, the electrification of railways, and a move away from coal, is behind this trend. Israel’s Ministry of Energy forecasts gas demand to hit 14 to 15 billion cubic metres (bcm) in 2025 and as much as 19bcm by 2030, up from just over 10bcm in 2017.

This, then, looks like a fertile market for the company. Energean’s Karish and Tanin projects, which lie off the northern coast of Israel in Mediterranean waters, are primed to take advantage. After pandemic-driven delays pushed the timetable back, Karish’s floating production, storage, and offloading (FPSO) vessel is now preparing for sail-away to Israel. Everything now looks set for the company to hit its target of first gas at Karish in the third quarter of this year.

As Berenberg analysts recently noted, Karish is “key to underpinning the company’s medium-term production growth and long-term cash flow profile”. After steadily scaling up, Energean hopes production can hit more than 200kboed (thousand barrels of oil equivalent per day) by 2024. Berenberg anticipates this will lead to average free cash flow of $735mn a year between 2023 to 2030, equivalent to an annual yield of around 28 per cent.

The group is also investing heavily to expand production. When the IC sat down with chief executive Mathios Rigas this month, he said the drilling programme his company is undertaking is the largest in the East Med – despite the presence of several supermajors in the region. The Athena exploration well, near Karish, has been spudded with the first drilling results expected in the second quarter of this year and the Karish Main 4, Karish North, Hermes, and Hercules wells are other confirmed or potential drilling sites.

When it comes to supply, gas contracts have been set for the long-term. Although spot prices are at record highs in some parts of the world, agreements struck in years past have allowed the company to advance its projects, while floor-price protection and take-or-pay provisions bring stability to cash flows and allow the company a good view over future earnings.

To date, Energean has put its signature on 18 gas sales agreements, representing a supply of over 7bcm a year of gas, which locks in sales for 16 years from the Karish, Karish North, and Tanin projects. And the company won’t be entirely cut off from the effects of surging global gas demand this decade, as a spot agreement in place with Israel Electricity Company, the country’s largest consumer of natural gas, gives the flexibility to raise offtake volumes towards FPSO capacity.

But there is also a contract dispute to keep an eye on. Dalia, the operator of Israel’s largest private power station, sought to terminate its agreement with Energean – which is now seeking damages for breach of contract. The value of the gas that would’ve been sold to Dalia is estimated by Energean to be in the range of $105mn to $407mn.

The company’s market is not restricted to Israel. Indeed, Rigas thinks Energean could play a role in helping with European demand as the continent pivots away from Russian energy in the wake of the invasion of Ukraine. Nor does the company have any operational, financing or supply chain exposure to Russia, which can’t be said for all companies in the sector. BP (BP.) is set to take a $25bn hit by offloading its 20 per cent stake in Rosneft, while Shell (SHEL) faces write-downs from its exit of the Nord Stream 2 pipeline and Russian-linked projects such as Salym and Gydan.

Not everyone is convinced of the wider potential of Israeli gas. Simon Henderson of think tank The Washington Institute believes it “will be important only in East Mediterranean terms rather than European terms”. Even if that proves prophetic, we are still looking at a business with solid growth potential and a very positive outlook.

As in Israel, Energean looks set to prosper from growing gas demand in Egypt as it gradually transitions its energy policy towards renewables. Fitch Solutions estimate that demand will hit 77bcm by 2028, up from 65bcm in 2021. First gas from the North East Almeyra/North Idku project is expected in the second half of this year, two years after Energean entered the country via the acquisition of Edison E&P.

Full-year results, published last week, also suggested a kink in that deal has been ironed out, after a concerted push to lower Egyptian receivables resulted in the balance dropping to a record low of $95mn at the end of December, against $240mn three years earlier.

Dividends and results

So far, so promising. Even better, the company is making the right noises on shareholder returns. Rigas’ acknowledgement of the challenges “the industry has faced [in] promising to pay investors dividends but then disappointing them” looks to us like a sign that he takes the matter seriously.

Assuming there are no issues with Karish– a risk that can never be discounted when it comes to complex resources projects – it looks like that won’t be a problem. The company aims to pay out its first dividend, of at least $50mn, by the final quarter of this year and is aiming to quickly bump this up and distribute at least $1bn by 2025. This isn’t to imply that the company plans to present itself as an income stock, although the news is certainly promising for investors. 

Preliminary results for the 2021 financial year demonstrate that things are moving in the right direction. Revenue climbed by almost half (on a pro-forma basis) to $497mn as Energean benefited from higher commodity prices and the integration of Edison E&P. The deal – initially inked in 2019 and which management described as “transformational” – came with production assets in Egypt, Italy, the UK and Croatia, and development assets in Egypt and Italy, boosting production and cash flows and widening the company’s ambitions.

Naturally, expansion has been accompanied by rising leverage. Net debt sat at just over $2bn at the year-end and is forecast to peak at between $2.6bn and $2.8bn in 2022, just as Karish comes online. While this might seem worrying, the company has access to over $1bn in available liquidity, its key project has been largely de-risked and there are no immediate debt maturities, with a weighted average of six years.

Over the medium term, management wants to see the ratio of net debt to Ebitdax (earnings before interest, tax, depreciation, amortisation, and exploration expenses) to fall below 1.5 times. That looks achievable.

For those investors wary of getting involved in fossil fuel production, Energean may nonetheless be an attractive option. The company aims to be net zero by 2050 and claims to have cut its carbon emissions intensity by 8 per cent in 2021, down to 18.3kg of CO2 per barrel of oil. So far, there have been been “zero serious incidents, oil spills and environmental damage”.

But it does intend to keep drilling. To Stifel analysts, that is an invitation to investors to “increase exposure ahead of the potentially transformational exploration programme”, although many will query the long-term future of hydrocarbon exploration, particularly in fields located in the UK and the EU.

Still, for those who accept the realpolitik of current energy demand, Energean’s near-term growth profile, backed by a ramp up in output and exploration, looks explosive.

Last IC View: Buy, 579p, 19 May 2020