Beach Energy Riding The Cash Wave

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

Is Beach Energy in an enviable position? Several brokers believe so, as the cash and reserve upgrades flow.

-Increased confidence in Cooper Basin production levels
-Lack of growth options in existing portfolio
-Sustainable business can now be prudent about acquisitions
 

By Eva Brocklehurst

Several brokers consider mid cap oil & gas producer Beach Energy ((BPT)) to be in an enviable position. Positive free cash flow and 179% reserve replacement were achieved in FY17. Beach Energy has grown its business from drilling in South Australia's Cooper Basin over many years, along with acquisitions.

This is a different business to what it was a few years ago, Credit Suisse suggests. The broker suspects the upside is materially undervalued. While the Cooper's Western Flank cannot go on forever, the next few years should provide a guide as to how much more there is.

What sets the company aside, and what may not be fully appreciated in Credit Suisse's view, is that it generates material free cash flow while replacing reserves, and now the business is high-quality and sustainable it can be truly prudent and disciplined about the opportunities.

The broker calculates that even at a oil price of US$50/bbl, if the company only achieved a 100% required rate of return (RRR) to the end of FY19, free cash flow would equal around 30% of the enterprise value of the business over the next three years.

In comparison, Credit Suisse finds few global companies in this field are sustainably replacing reserves and still generating more than 10% free cash flow yield at such an oil price. Moreover, now the business is high-quality and sustainable it can be truly prudent and disciplined about the opportunities.

Proven & probable (2P) oil and gas reserves rose 7% and were 75mmboe at year's end, due to ongoing development and appraisal drilling and better-than-expected performance from the Western Flank oil fields. Canaccord Genuity believes this outcome should provide the confidence that production will stay above 10mmboe the foreseeable future.

Oil Vs Gas

Morgan Stanley also considers the recent reserve upgrades a reason to become bullish, while the business trades on undemanding metrics. The broker upgraded to Overweight from Equal-weight recently and expects consensus valuations will rise as confidence in the Cooper Basin increases.

Macquarie is less enthusiastic and continues to believe the company lacks growth opportunities within its existing portfolio, which is expected to remain at around 10mmboe over FY18-20, with the later years contingent on exploration success.

Within the large reserve upgrades the increases have come from the liquids-rich discoveries and Macquarie believes the company will prioritise the higher-margin condensate and LPG, meaning lower gas volumes.

The stock is currently trading at an implied oil price of US$54/bbl, and Macquarie expects 2018 pricing will weaken because of additional volumes from OPEC and sustained strength in US production.

Shaw and Partners suggests the balance sheet is begging to be leveraged and, in the absence of acquisition opportunities, the Cooper Basin asset appears maximised. The company makes most of its money from the Western Flank oil fields and increased investment is required in 2018 to maintain production levels or mitigate declines.

Shaw and Partners also believes growth is challenged: reserves and production growth in FY17 came from 58 wells, making the operations labour and drilling intensive.

The broker acknowledges the company is generating strong levels of free cash flow, and is well-placed to undertake asset purchase should the opportunity arise, but considers the stock fully priced. Shaw and Partners, not one of the eight brokers monitored daily on the FNArena database, has a Sell rating and $0.58 target.

While the Western Flank may not be a resource play as such, Canaccord Genuity suggests it has enough to support the company's goals. Despite an improved gas price and cost outlook, the SACB joint venture was the only asset where reserve replacements did not exceed 100%.

As the asset experienced material downgrades during the oil price slump, the broker considers there is a real potential for reserves to be written back. Canaccord Genuity, not one of the eight monitored daily on the database, raises the target to $0.90 and retains a Buy rating.

Citi recently downgraded to Neutral from Buy because of the jump in the share price post the result but acknowledges a positive outlook for the company, given cost reductions and reserves growth.

Raising Profile?

Credit Suisse suggests that, in part because of a market cap of around $1.3bn, large cap fund managers can afford to ignore the stock. For sure, the history of capital allocation is chequered but Credit Suisse defends the company because of the type of exploration.

The bigger end of town tends to have a huge contingent resource base, which can be modelled, and then risk allocated depending on the likelihood of development going ahead.

This is not the case with Beach Energy, therefore valuing exploration upside is difficult. How the market can capture the upside will probably depend, the broker suspects, on the company reaching its target of over 100% RRR in FY18.

Morgan Stanley believes the stock will become one of the mid-caps of choice in Australia for investors wanting exposure to energy. This is on the basis of its scale and steady production as well as improving cost structures in the Cooper Basin.

The broker agrees the company is exercising more discipline in its acquisitions. An acquisition outside the Cooper Basin would provide more gas exposure, greater reserve life and scale, and the market should reward this as long as discipline is exercised.

Canaccord believes the Cooper Basin has often been viewed as an asset in constant decline (Western Flank) or marginal, as in the case of the SACB joint venture. Both major protagonists, Beach Energy and, more recently Santos ((STO)), have been keen to change this perception.

The broker believes the FY17 results support a review of the case. The vast bulk of the additional reserves was driven by the identification of new well locations in existing fields and a better production performance than previously anticipated.

FNArena's database shows two Buy, three Hold and one Sell (Macquarie). The consensus target is 75c, suggesting 12.9% upside to the last share price. Targets range from 65c (Macquarie) to 80c (Credit Suisse, Morgan Stanley).
 

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