Small Caps | Feb 05 2015
-Stock potentially undervalued
-China's focus on gas supportive
-Pilots progressing
-Potential reserve upgrade
By Eva Brocklehurst
Sino Gas and Energy Holdings ((SEH)) has caught the attention of broker Canaccord Genuity, which expects 2015 to provide significant catalysts for the stock, a pure play in the Chinese domestic gas market.
The company moved into pilot production late last year at its Chinese projects and expects to be producing around 50Mmscfd of gas by end of 2016. This production growth should be able to be funded from existing liquidity, whilst generating significant reserve conversion and enabling debt funding of full field development or additional pilot expansion. The broker anticipates a financing facility of no less than US$140m will be required to fund the company's share of the base case development scenario. This debt level would result in a manageable 64% debt/equity ratio, peaking in 2017.
Canaccord Genuity has initiated coverage with a Buy rating and 33c target, noting the company is heading for a small but symbolic operating profit this year. Sino Gas and Energy holds two licences in the Shanxi province of northern China. These tight gas projects are low on the cost curve and set to benefit from rising gas prices. China is targeting natural gas to be more than 10% of its energy mix by 2020, corresponding to a 14% compound growth rate over the next several years.
The gas will eventually be marketed by Chinese partners and Canaccord Genuity understands eventual offtake and connection to the pipeline is highly achievable, although key risks remain around geology, price and timing as well as scale of development.
The broker believes the current share price offers significant downside protection. Even under a maximum reasonable adversity scenario, valuation support is evident at current levels. Including a US$7.5/Mcf gas price and development plan approval delay until 2018 in sensitivities, the broker's risked valuation reduces to 14c. This justifies the current share price and suggests to the broker the stock is currently undervalued.
Acknowledging the risks around extracting full value from the project, Canaccord Genuity considers the market is either overly pessimistic on the outcome or is too aggressively discounting the stock based on single risk factors.
Moreover, significant increases to reserves are expected soon and pilot production from Linxing West is to be connected mid 2015. The Ordos Basin is one of China's most prolific gas regions and multiple unconventional fields have been developed, with significant pipeline capacity running through the company's acreage. There are 94 wells, drilled across both Linxing and Sanjiaobei. Sanjiaobei is currently in pilot production. Linxing East has small shallow CSG resources but is viewed as less attractive.
Macquarie recently noted pilot production was progressing well and bode well for a reserve upgrade. The broker retains an Outperform rating and 35c target.
Sino Gas and Energy listed on ASX in 2009 and holds a 49% stake in the operating company in partnership with China's MIE Holdings. There are two key regulatory hurdles before full field development is secured. First a reserve report is required and, secondly, an overall development plan. In Canaccord Genuity's view a realistic timeframe for these approvals is the end of 2015 and 2016 respectively. A draft report on reserves is underway and the broker expects formal submission is just a few months away.
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