Morgans senior analyst, Adrian's report on SXY and COE

After the announcement of Q3' FY19, I've gained more information for estimating Q4'FY19 and FY20's earnings. This post has two parts. The first part is on de-risking.

For Roma North，the gas processing facility is nearing completion. So Senex is expecting its first 'processed' gas sales to Santos's GLNG by mid-2019. (The gas that Senex is selling to Santos now is 'raw' gas, not 'processed' gas. Raw gas has lower sales prices.) I think the de-risking for Roman project is pretty much near completion. First, its funding problem is solved and it has already had a buyer (Santos) for all its gas. Second, the 30 wells in phase 2 has already proven their commercializability. So, the 50 wells to be drilled in phase 3 should be fine too, given their similarities.

Project Atlas will start drilling on Jul - Sep 2019, with first sale to be expected on Jan 2020. I think the main risks for Atlas center on its production and not on its sales. Since the local demand for gas in the east coast is gradually outstripping supply, selling the gas shouldn't be a problem. But, according to Morgans's analyst, Adrian, the execution for Atlas should not be a big problem due to its high productivity. Specifically he said:

“On our estimates SXY can fully develop its Roma North project for an equivalent all-in cost of ~A$5.0/GJ (including capex/finance) on the 15 TJ/d base case, without factoring in the possible capacity expansion of an additional 8 TJ/d. Given the coals in Project Atlas could be 2-2.5x as productive as Roma North it is hard to see a scenario where the breakeven hurdle is not lower than Roma North. This presents an easy set of economic hurdles for SXY gas to be commercialized. At its current share price this leaves SXY looking like a bargain, with too much discount factored in for execution risk.”

Adrian has a Master in Science (majoring in Mineral and Energy Economics) and he's a mining and energy economist. His judgement on Atlas vs Roman's productivity is right. Atlas will be drilling 60 wells and is expected to produce at a plateau rate of 32Tj/day. RomaN will be drilling 50 wells, but it's only expected to produce 16Tj/day at plateau.

Interestingly, he estimated the 'all-in-cost' for RomaN to be around $5.0/Gj. If that's true, would the all-in-cost per Gj for Atlas be even lower given its 200-250% higher productivity compares to that of RomaN? If the answer is positive, with gas on the east coast now changing hands at $9-$11/Gj, Atlas will be quite profitable, then.

Another interesting piece is that Adrian gave Cooper Energy a target price of $0.59 (market cap $956.7 mil) and COE is already trading now at $0.535 (MC -$867.5 mil). He gave SXY a target price of $0.57 (MC - $828.2 mil) but SXY is only trading now at $0.365 (MC - $530.3 mil).

It’s important to note that Adrian is using the DCF model calculate his target price. This valuation model which assumes that a business can ‘perpetually’ grow into the future, indiscriminately favors COE, of which assets have stronger but shorter cash generating life cycles, compare to those of SXY. Had the NAV (Net asset value) model been used to value the two, SXY should get a higher valuation than COE. SXY has 2P reserves of 113.2 mmboe but COE only has 2P of 52.4 mmboe. So, SXY’s cash flow generating life cycle can be twice as long as COE’s. (For example, SXY has a ‘20-year’ binding gas sales agreement to supply up to 50Tj/day to Santos’s GLNG)

(As the assets of O&G companies have limited lives, some firms use NAV model to value them. This model takes production decline rate into account and allow them to estimate cash flow until the O&G reserves fully deplete.)

And, regarding SXY’s aggregate cash flow generating capacity, don’t forget 3 things: 1) The estimate has yet to include the Gemba gas reserve; 2) RomaN’s Glenora & Eos blocks are only part of the larger West Surat gas project. (Total 2P of WSGP = 80.5 mmboe, Gle & Eos blocks = 32.5 mmboe); and 3) Atlas's current 2P is 24.5 mmboe. The estimate has yet to take into account the ultimate recovery of Atlas acreage, of up to 65% - which can add another 47.3 mmboe to SXY’s total 2P reserves. (According to SXY announcement, 31 Jul 18, “2018 Annual Reserves Statement”, on Project Atlas, “ NSAI have estimated approximately 427 PJ (72.0 mmboe) of original gas-in-place (OGIP), and the proximity of producing wells to the north, west and south of the block resulted in the booking of 144 PJ (24.5 mmboe) of 2P reserves at 30 June 2018. This equates to a raw gas recovery factor of 37%. Based on current work to date, Senex is targeting ultimate recovery of up to 65% of OGIP over the life of the project, equating to approximately 278 PJ (47.3 mmboe) of recoverable gas.” )

But, in the end, who cares which model is used to value SXY and COE. Even under the DCF model (which could be under-estimating the much longer cash generating lives of SXY's assets, relative to those of COE), SXY is still failing to catch up with the target price it generated. $0.57 - Wow, so far away!

I have attached Adrian’s report on SXY and COE here. Why SXY vs COE? SXY and COE are the only two in ASX O&G sector that are going to experience explosive growth in production in the short- to mid-term. So, they are perfectly comparable. SXY is very not comparable to, for example, Beach Energy, which is transforming itself into a free-cash-flow, moderate-capex, dividend-paying but moderate-growth company. Enjoy your read!