Beach Energy Becomes More Compelling

This story features BEACH ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: BPT

Beach Energy plans to acquire Lattice Energy, substantially increasing its scale and diversity.

-Acquisition reduces exposure to oil price movements
-Stock becomes more compelling with scale
-Development opportunities a-plenty as capital has likely been constrained
 

By Eva Brocklehurst

Beach Energy ((BPT)) is broadening its horizons, and given the size of its proposed acquisition of Lattice Energy, brokers suggest it will take time to understand the new business fully.

The company will acquire Origin Energy's ((ORG)) Lattice Energy for $1.585bn and fund the transaction via a combination of debt and new equity. Beach Energy expects a rapid reduction in gearing is still possible, outlining a near-term target of under 25% by the end of FY19.

This is expected to be achieved whilst maintaining exploration capital expenditure to replenish declining oil output in the Western Flank. The acquisition of Lattice also means the company diversifies away from the Cooper Basin, reducing exposure to oil price movements.

While the management team is considered capable, Morgan Stanley points out the risk profile has increased substantially for the business. This is compounded by the fact that some of the acquired assets, such as BassGas, historically have been troublesome, with greater expenditure required than previously anticipated and reserve performance lower than expected.

The broker suspects that in time, the market will reward the transaction, as the company has the opportunity to build a substantial business and its scale, footprint and cash flow will become more interesting.

Gas Price Risk Vs Oil Exposure

Most of the gas from the Lattice east coast assets is sold under contract to Origin Energy. While the actual price was not disclosed, Beach Energy did note its average gas price would be higher than the $6.10/gigajoule achieved in FY17. Operating cash flow is expected to increase by over 60%.

UBS believes the fixed nature of some of the acquired contracts should reduce oil price exposure and increase revenue certainty for Beach Energy. The company has also identified $20m in cost synergies to be realised within the first 12 months.

Capital expenditure programs have a large discretionary component and provide significant flexibility, the broker notes. Almost 50% of Lattice reserves are undeveloped and may require over $800m to unlock the value. Further upside could come from re-pricing of gas contracts in FY21 and exploration upside in offshore Victoria and onshore Perth Basin.

As an aside, UBS expects a continued recovery in oil prices over the next few years, assisted by the OPEC decision to reduce output. Three consecutive years of under-investment in conventional oil supplies should lead to larger oil deficits from 2018 and, in the broker's view, justify higher oil prices to incentivise new investment.

Citi agrees now that risk around the deal has reduced and the company diversifies its portfolio and cash flow away from the Cooper Basin, this has improved the earnings outlook and reduced oil dependency. Ord Minnett, too, finds a number of positives from the announcement, expecting the transaction will be significantly accretive.

Many of the new gas supply agreements signed with Origin Energy expire within three years, which provides medium-term exposure to spot gas prices. There also could be development opportunities as capital for the assets has probably been constrained.

Fair Value?

Citi welcomes the company using its debt capacity, after almost 10 years of running a lazy balance sheet, along with a $300m rights issue, to obtain Lattice Energy. The stock now appears compelling to the broker on several metrics, including an enterprise value:operating earnings (EBITDA) basis as well as free cash flow yield.

This outlook comes before factoring in the upside from the company working its assets harder and, while concerns remain regarding replacing existing production, future growth can be built from these cash flows.

Citi upgrades to Buy from Neutral and believes, while some uncertainty may exist regarding these assets because many investors are looking at them for the first time, delivery of earnings and potential for material cost savings should demonstrate value in the end.

Most of the value uplift comes from the acquisition at a discount to the broker's fair valuation of the assets, modelled for Origin, and partially offset by the diversion from the equity raising. The main issue for Citi is that while the assets generate substantial cash flow, there is a mixed performance history which has left a very high level of depreciation and negligible profits for Lattice Energy, historically, in Origin Energy accounts.

At a minimum, Citi expects Beach Energy will adjust down the carrying value for the Cooper Basin and/or Otway given recent market valuation to ensure earnings are accretive.

Morgan Stanley finds it difficult to judge whether the price for the acquisition was fair as the actual gas pricing was not disclosed. Ultimately, cash flow is what's important and, while further details on gas pricing and cash generation are required, the broker suspects the acquisition price paid was fair to full.

The price of Lattice Energy gas, as flagged by the company, makes sense to Morgan Stanley, with industry conversations pointing to new contracts across the east coast of Australia being done in the $7-10/GJ range.

Lattice Energy

Lattice Energy comprises most of Origin's non-LNG assets, including an extra 10-12% interest in the Cooper Basin joint venture, where Beach Energy already has 20-22%, as well as operating interests in gas fields in offshore Victoria (Bass Gas and Otway).

There is a 50% operating interest in Kupe, New Zealand, as well as a 50% interest in Waitsia, Perth Basin. Post this transaction Beach Energy's reserves would increase by around 200% and FY18 production by around 150%, according to the company's statement. Completion of the transaction is subject to NZ government approvals which are expected by the end of the year.

There are three Buy ratings, two Hold and one Sell (Macquarie, yet to comment on the Lattice Energy acquisition) on FNArena's database. The consensus target is $0.80, suggesting -5.9% downside to the last share price. Targets range from $0.65 (Macquarie) to $0.92 (Citi).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms