Australia | Feb 12 2020
If Beach Energy's drilling success continues and oil & gas prices hold up, then brokers believe a substantial increase in planned capital expenditure may be justified.
-Upside price potential eroded by recent reduction in east coast gas prices
-Is momentum on cost reductions stalling?
-More explanation required regarding the extent of capital expenditure plans
By Eva Brocklehurst
Beach Energy ((BPT)) has flagged a positive outlook for the second half, expecting several projects will start to contribute significantly to growth. However, the market reaction was fixated on a substantial hike in capital expenditure.
While drilling success in the first half was above 80%, and the company has modelled a lower rate for its five-year outlook, brokers consider further success will be crucial to justifying the expanded expenditure.
A near term commercialisation path for Perth Basin gas has been outlined, which could indicate a larger-scale development, and Morgans expects the Otway and Perth developments will deliver the bulk of production gains in FY21/23.
Credit Suisse expects a probable upgrade to the five-year production outlook and reserves in mid 2020, driven by Bauer output. That said, the broker remains cautious and wonders whether more expenditure will creep in after FY20.
At this stage, Credit Suisse has faith that management's plans are solid and believes the recent sell-off in the stock is a little overdone. Nevertheless, Beach Energy will likely require a strong second half to achieve its guidance, in Macquarie's view.
While the company expects around 80% of gas contracts to be on updated pricing over the next three years, the broker notes upside potential has been eroded somewhat, given the recent reduction in east coast gas prices.
Oil & Gas Prices
Macquarie assesses the risk to oil and gas prices has intensified, noting, while the company has adjusted its Brent assumptions to US$60/bbl (spot price is US$53.31/bbl) which puts downside risk on earnings guidance.
However, the broker points out Beach Energy has paid down a significant amount of debt in the last two years and moved to a net cash position at the end of the first half. Morgan Stanley counters this, forecasting net debt to increase as operating cash reduces over the next 12 months, given momentum on cost reductions appears to be stalling.
This creates risks, should commodity prices come under further pressure. The broker expects prices will be lower than what was assumed by the market 12 months ago, pointing out reserve increases from the Western Flank will not last forever.
Given lower gas production, capital expenditure increases and falling commodity prices Morgans expects free cash flow in the near term will be weaker. While Beach Energy cannot do much about oil prices, free cash flow should be driven by the development program across its assets, the broker asserts.
Morgans lowers assumptions for crude in FY20/21 but maintains long-term assumptions of US$70/bbl. While the stock has fallen in the last month, the broker believes Beach Energy needs to rebuild confidence, and this will probably occur at the full year result amid reserve upgrades and more clarity on the work program.
In order to reach its five-year targets Beach Energy has increased guidance for capital expenditure to $875-950m, well above the $447m incurred in FY19. Most expenditure is likely to be on development wells in the Western Flank and Cooper Basin.
The company had indicated back in August 2019 that near-term cash flow was being sacrificed to drive growth and Ord Minnett notes, at that time, investors were worried about waiting longer for cash returns from growth projects.
This concern is now exacerbated. Beach Energy has allowed an additional $50m in the second half for exploration and appraisal and another $50m has been identified for the Cooper Basin oil production.
Citi, too, points out investors are interested in further understanding why expenditure guidance has been raised and the extent to which this and other disclosures will affect future free cash flow, pulling back some of its more aggressive assumptions.
Initial concerns over the expenditure have been somewhat allayed, Credit Suisse asserts, after the conference call, noting Perth Basin upside could be larger than the market anticipates.
Still, Citi has several questions regarding the capital expenditure program, such as how management can get costs under control without jeopardising operating integrity.
The original work program did not factor in the number of horizontal wells that are now planned, although the hiring of new staff was elevated to mitigate the risk of poor execution and the broker acknowledges some of these costs could be removed in future, depending on the scope of works.
On balance, Citi suspects there is upside risk to the outlook and expects free cash flow largely in line with the prevailing five-year outlook. On the other hand, Morgan Stanley finds it difficult to envisage a further re-rating on the stock unless exploration wells perform.
FNArena's database has four Hold ratings and two Sell. The consensus target is $2.33, suggesting 3.9% upside to the last share price. Targets range from $2.00 (Morgan Stanley) to $2.49 (Credit Suisse).
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