Investors in London’s junior oil and gas stocks are rarely short of opportunities. Geological potential is frequently ‘world-class’, discoveries are always bountiful (until they are not), and shareholder returns are often quantified in dramatic stock-price spikes, not sustainable returns. SDX Energy (SDX) explores for oil and gas in North Africa, so it is partly dressed in that panoply. But the firm could equally fit into another, and more enviable, sub-category: low-cost producer with debt-free, cash-rich balance sheet, focused management and growing cash flow. So while exposure to energy prices, operations in Egypt and the inherent speculative quality of drilling are all risks, SDX’s cash safety net and profitability mean this stock’s opportunity extends beyond wildcat drilling, and to a decent valuation argument.
Excellent margins
Drilling success
No debt
Growing cash flows
Commodity prices
Development risks
SDX started life as a public company when its shares were listed in Toronto in 2008, but for our purposes the story has only fired into life in the past two years. After joining the Alternative Investment Market in 2016, the company was transformed last January when it acquired the Egyptian and Moroccan businesses of Circle Oil, a fellow energy minnow which had collapsed into administration. Although the bidding process was competitive, SDX paid just $30m (£22m) to secure assets whose carrying value had swelled by $34m by September, excluding depreciation. The deal immediately quadrupled SDX’s production, more than tripled its reserves base, and caused a surge in cash flows.
You might assume 2017 finished with costly debt, but SDX's bosses have acted as a measured financial steward. Indeed, analysts at broker Edison reckon 2017 ended with around $25.5m in the bank, equivalent to more than a fifth of SDX’s market value. And the balance sheet should improve further as SDX's main counter-party, the Egyptian state oil group EGPC, clears its back payments to SDX. That has been the trend, and explains why management and analysts are confident SDX's heavy working capital commitment will gradually improve.
The situation in Morocco is arguably better. SDX is the only domestic producer of gas in the country, and expects to increase production from 6m cubic feet per day to 10m by the end of 2018. Long-dated contracts have locked in netbacks (that is, sales minus operating costs) of around $9 per thousand cubic feet sold. Assuming all goes to plan, monthly operating cash flows from the Moroccan base alone could hit $2.7m by December. The longer-term investment case rests on plans to boost daily production to 24m cubic feet, incentivised by a 10-year tax holiday and an industrial customer base hungry for reliable, competitively-priced energy. Getting to that point, which involves doubling the gas reserves base, should not be a problem if SDX continues its 80 per cent drilling success rate, just over halfway through a nine-well exploration programme.
| SDX ENERGY (SDX) | ||||
| ORD PRICE: | 49p | MARKET VALUE: | £99.7m | |
| TOUCH: | 47.5-49p | 12-MONTH HIGH: | 71p | LOW: 40p |
| FORWARD DIVIDEND YIELD: | nil | FORWARD PE RATIO: | 5 | |
| NET ASSET VALUE: | 41p | NET CASH: | $30.5m | |
| Year to 31 Dec | Turnover ($m) | Pre-tax profit ($m) | Earnings per share (¢) | Dividend per share (¢) |
| 2015 | 11.4 | 11.1 | 26.7 | nil |
| 2016 | 12.9 | -26.7 | -13.8 | nil |
| 2017* | 36.3 | 6.0 | 2.7 | nil |
| 2018* | 65.2 | 31.2 | 14.8 | nil |
| % change | +80 | +418 | +450 | - |
| Normal market size: | 5,000 | |||
| Market makers: | 7 | |||
| Beta: | ns | |||
| *Edison forecasts; £1=$1.39 | ||||
