Small Caps | Sep 21 2021
This story features KAROON ENERGY LIMITED. For more info SHARE ANALYSIS: KAR
More detail is being gleaned about the Bauna field where Karoon Energy appears set to become a scale oil producer with growth potential
-Bauna field performing, decline rate better than previously expected
-Well budgets maintained, production growth to commence in FY23
-Strong free cash flow yields envisaged for Karoon Energy in FY23, FY24
By Eva Brocklehurst
The way forward for Karoon Energy ((KAR)) is becoming clearer, as further detail on Brazilian expansion plans was delivered with the FY21 results. Morgan Stanley finds the stock compelling, assessing around 50% upside to its discounted cash flow valuation at US$70/bbl, and amid the successful delivery of the Bauna interventions and drilling of the Patola wells.
The Bauna field is performing, with a decline rate of -10% in FY21, better than what was expected when the tenements were acquired. Macquarie was pleased and, following the upcoming drilling campaign, models 28,500 b/d production in FY24.
Morgans is impressed with FY22 production guidance of 4.2-4.6 mmbbl and also highlights the fact this guidance was based on a higher decline rate of -10-15%, suspecting Karoon may revisit guidance once maintenance of the company's FPSO chartered floating production/storage facility has been completed.
The Maersk rig will arrive in the second quarter of 2022. The workover program includes replacing submersible pumps at two wells with gas lift to be introduced to a third and the tapping of a new oil zone at a fourth. The rig will then move on to drilling Patola.
On the existing production rate of 14,000 b/d, Karoon has maintained a budget for well workover at US$110-130m and the Patola development at US$175-195m, expecting production growth will commence early in FY23.
While cost guidance of US$28-32/bbl for FY22 is higher than brokers previously expected, this is assumed to reduce to below US$20/bbl after production receives a boost from the current well interventions and drilling at Patola.
The rise in production costs is temporary and should fall as production rises from FY23, Morgan Stanley asserts, noting increased costs are partially stemming from maintenance expenses to address corrosion on FPSO piping.
The broker adjusts production costs to align with the FY22 forecasts and reduces the risking for Bauna to 90% from 80%, as Karoon Energy is incrementally moving towards higher production from the interventions in FY22 and reaching a final investment decision at the Patola wells.
Karoon is required by financiers to hedge a floor for 40% of production in the first rolling 12 month period and 30% in the second 12 months and, based on market conditions, Macquarie finds the hedging ranges attractive.
The broker reduces estimates for earnings per share by -40% in FY22 amid higher depreciation and increased maintenance costs, partially offset by higher oil production. Morgan Stanley also reduces FY22 estimates by -40% while raising FY23 by 18%.
The inclusion of Neon and Goia, where the company can elect to drill a control well after Patola, has also provided Macquarie with greater confidence in the cash flow that will be generated.
Management considers the most feasible development for Neon is a tieback to the existing FPSO at Bauna. Morgans notes this is different from the original plan where a stand-alone development was envisaged. No mention was made of Goia this regard and the broker does not include it in modelling.
Morgan Stanley currently values Neon and Goia at US$77m, at the lower end of the resource base and, as there is still risk, acknowledges further drilling will be required. The broker anticipates strong free cash flow yields of 15% or more in FY23 and 30% or more in FY24, which will provide further opportunities for expansion in Brazil.
More detail should be forthcoming at the strategy update in October. Morgans agrees potential acquisition opportunities would complement the Bauna operations and believes the stock offers a unique opportunity as a high-margin pure oil producer with scale and growth potential.
FNArena's database has three Buy rating with a consensus target of $1.80 that suggests 31.4% upside to the last share price.
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