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Nexus Energy (NXS.AX - A$1.90) Buy Target: A$4.52

Bell Potter has increased the oil price assumptions used for future cash flow projections of oil and gas companies. This follows a significant change from UBS, which is the source of all our macro-economic forecasts. The valuation for Nexus Energy (ASX code: NXS) is substantially impacted by this major oil price upgrade. This is primarily through its Crux condensate project, which is scheduled to commence production in 2011, when the oil price assumption has been increased by 73%, followed by an even bigger increase in 2012. Our valuation has increased from $2.76 to $4.52, a 64% increase and 138% above the current share price. Although oil price predictions are notoriously difficult to make, we agree that the previous assumptions were unrealistically low and that the oil price is very likely to trade over US$100 in the future, which is supported by trading in the futures market. As the company has no current earnings and the Longtom project is relatively modest from 2009, it is not until 2011 that the impact on EPS becomes evident. The Bell Potter EPS estimate for NXS in 2011 has more than doubled to $0.92, putting the stock on a PER of 2.1x. This is still some time away, but highlights the attractive growth profile of the stock.



Reasons to buy NXS



· Undervaluation, both on a discounted cash flow (DCF) basis as well as peer group comparisons. Although the $4.52 valuation may seem excessive, it is largely driven by the Crux project and our numbers are consistent with the company’s presentations. Also, the Enterprise Value per 2P reserves is still about $10/barrel, whereas the peer group trades in the $20-40 range. Are NXS’ reserves only worth half or a quarter of other companies’ reserves? We don’t think so.

· Exploration potential, particularly Libra-1 to be drilled in June, near the Crux project. This prospect may be an extension of Crux, and apart from potentially boosting reserves by 50%, it could upgrade other prospects to the east and south.

· The company’s growth prospects are very strong, which is particularly attractive when the majority of oil and gas companies around the world are struggling to replace production. This could make NXS a corporate target, particularly if it continues to trade at such a discount to industry values. A partial explanation for the discount is the market’s fear of an equity issue, as the company needs cash to fund its growth ambitions. As previously stated, we consider this concern overdone. We believe asset sell-downs will be favoured by the company, as NXS holds large equity stakes in both Longtom and Crux. The Longtom project could be sold down to 50% for $100m, or a 35% stake in Crux could be sold for $300-500m. NXS would still retain big equity stakes and operatorship in these projects and funding would not be an issue.