SEPLAT FY-2019 Audited Result: Headed for tougher times?

Earlier, SEPLAT published its FY-2019 earnings, recording a basic EPS from continuing operations of $0.46 vs $0.26 in 2018.  The Energy giant posted a 6.5% y/y decline in revenue, majorly on the back of lower pricing and weaker production volumes. The company also completed its acquisition of Eland Oil & Gas, which is set to increase its working interest 2P reserves by 36.0mmbbls. A final dividend of $0.05 was declared for FY-2019. Going into 2020, the road appears tougher, given the volatility in the global crude oil market. As such, investments in gas and drilling operations are likely to slow, as the company strives towards staying afloat. A critical look into its financial performance and outlook are further explained below.

Tax credit and Lower finance costs paint profits in bright colours
For FY-2019, SEPLAT’s Revenue (-6.5% y/y) came in lower at $697.8mn, fuelled by declines in both production (Working Interest Production dropped by 6.8% y/y to 46,498 boepd) and lower prices (average realised oil prices down 8.1% y/y to $64.4/b and average realised gas prices down 3.4% y/y to $2.84/mscf). Judging by the responses of management on its Analysts’ call, the decline in WIP was as a result of delays in mobilization of oil rigs, as well as the declining nature of mature fields. Dissecting the components of Revenue, contribution from Gas operations increased to 29.0% vs 20.9% in 2018, at $202.7mn, while contribution from Oil operations reduced to 71.0% compared to 79.1% in 2018, at $495.1mn. However, the larger proportion of gas revenue was buoyed by a one-off recognition of gas tolling revenues owed by NPDC within the period of 2015-2018.

In terms of production costs, the decrease in production volumes for 2019, resulted in lower royalties cost, crude handling fees and DDA (depletion, depreciation and amortisation). Hence, Cost of Sales declined by -14.9% y/y to $302.0mn, bolstering Gross margin to 56.7% against 52.4% in 2018. Also, SEPLAT’s OPEX (G&A) fell 11.4% to $70.6, and Operating margin improved to 44.7% vs 41.5% in 2018. Finally, with reduction in interest payment on bank loans, finance cost came in lower even as the benefits of a two-year extended tax holiday on gas operations (ending May 2020) gave the bottom line some support. As a result, both Profit Before Tax (PBT) and Profit after Tax (PAT from continuing operations) increased by 11.3% y/y and 80.1% y/y to $293.0mn and $263.8mn respectively.

Eland acquisition came at a price - Financial leverage up y/y
SEPLAT ramped up capital spending in 2019, with CAPEX up 42.0% y/y to $124.8mn, focused mainly on additions from production and field facilities (nine development wells and facility upgrades). However, this was lower than the half year revised guidance for CAPEX at $150.0mn. The increased CAPEX filtered into the 23.2% y/y growth we saw in total PPE ($1.6bn), as well as assets worth $370.1mn, arising from the Eland acquisition. Elsewhere, working capital (CA-CL) decreased by 45.3% y/y to $309.6mn, due to an increase of 11.4x, in short term borrowings ($112.3mn). Alongside the large increase in long term borrowing (+55.3% y/y to $677.1mn), the increase in short term borrowings prompted higher leverage, as Debt/Equity ratio increased from 27.8% to 43.8%. The increase in borrowings was sparked by the take-off of a $350.0mn four-year Revolving Credit Facility, of which SEPLAT drew down the entire facility to fund the acquisition of Eland. Notably, the company booked a liability from a $125.0mn Reserve Based lending Facility, through its subsidiary, Westport. Overall, the company moved from a from net cash position in 2018 at $139.0mn, to a net debt position of $456.4mn in 2019. Also worthy of note in the acquisition of Eland is that SEPLAT acquired the right to be repaid $414.0mn from Westport (a financing subsidiary for OML 40) spread over 2022 to 2024. By implication, until the loan is repaid, Eland will hold a working interest of 45% in OML 40, after which it will revert to the original 20.25%.

Heavy investing activities weighed on cash flows
Analysing generation of cash from its core business, cash inflow from operations declined by 32.7% y/y to $337.8mn, owing to a large $311.0mn increase in Trade and other receivables. As a result, Operating Cash Flow (OCF)/CAPEX ratio – a measure of much operating cash flows covers capital expenditure- decreased to 2.7x, from 5.7x in 2018. Overall, due to significant investing activity, total cash generated within the period decreased by 43.8% to $326.6mn, as major cash outflows - Eland acquisition (-$451.2mn), cash removed via the deconsolidation of ANOH Gas Processing Company (-$154.2mn), CAPEX (-$124.8mn), and share of equity contribution in ANOH (-$103.1mn), - outweighed major inflows from operating activities (+$337.8mn), net proceeds from financing (+$203.9mn), Oben Gas plant proceeds (+50.6mn) and receipts from OML 55 (+$36.2mn).

Outlook in 2020 – SEPLAT rated a HOLD at current price
Given the current volatility and depressed pricing in the global crude oil market, we expect SEPLAT to be more cautious in terms of spending and liquidity management in 2020. Compared to 2019, working interest production guidance for 2020 was slashed to 41,000-47,000boepd for SEPLAT only. Additionally, with Eland on board, expected to produce between 6,000 -10,000bpd (it achieved WIP of 8,963bpd in 2019), total WIP in 2020 will be higher. Also, planned CAPEX spending for 2020 has been reduced to $100mn, of which $50mn has been spent in Q1-2020. As such, drilling programmes are likely to be focused on high returning wells. The company has indicated at least three wells of focus, rather than nine wells that were drilled in 2019. We also expect production OPEX, which increased to $6.2/boe in 2019 vs 5.8/boe in 2018, to be more prudently managed in 2020.

In terms of pricing, the current oil price environment, hovering around $26/b to $27/b gives us a bit of concern. To reduce that exposure, we understand that SEPLAT hedged 1.5MMbbls of oil per quarter (Q1-2020 to Q3-2020) at US$45/bbl, about 58.4% of its previous production in 2019 (7.7mmbls). While the hedge may shore up profitability in the short term, the medium to long term impact of COVID-19 on crude oil demand and the outlook on how the price war between OPEC members, Russia and non-OPEC exporters will eventually play out, remains a concern. However, the management in its analyst call, hinted that the breakeven price for SEPLAT is slightly around $20/b. Hence, we expect production to remain profitable so long as prices continue to average above $20/b.

Bearing the above in mind we downgrade our rating to HOLD, as the outlook on oil prices remains bleak. Using the NAV methodology, with a WACC of 10.0%, as well as oil and gas price forecasts for the near and long-term, our Year-end target price for SEPLAT is N552.5, with an upside of 1.5%. Although near term profitability is challenged, seeing how SEPLAT weathered the storm in form of the 2015/2016 oil supply glut, we expect the company’s history of an efficient cost reduction strategy, adequate cash balances and partially hedged exposure to provide support, once oil prices take a positive turn, following the mitigation of the COVID-19 pandemic.