Beach Energy Steps On The Gas

This story features BEACH ENERGY LIMITED. For more info SHARE ANALYSIS: BPT

Beach Energy is playing into an increasingly tight gas & LNG market, so a refreshed outlook and production target have been welcomed

-Production growth is coming from committed development projects
-Target for FY24 does not include any exploration upside
-Can the stock outperform during a period of investment risk?
 

By Eva Brocklehurst

Gas markets are tightening, great for Beach Energy ((BPT)), which is increasingly exposed to not only Australasian gas markets but also global LNG. Market confidence has improved as more detail on growth prospects has been provided, particularly for the Otway Basin in Victoria and the Waitsia stage 2 LNG project in Western Australia.

Ord Minnett notes these projects should more than offset what looks to be like significant declines in Western Flank production (Cooper Basin) and in the absence of any exploration success.

The broker believes the market should be satisfied with a presentation that goes some way to re-establishing any credibility Beach Energy lost during a year of disappointments and write-downs. Moreover, production growth is coming from development projects which have already been committed.

The company is expected to benefit from its diversified gas projects which include eight processing plants located in five basins. Bell Potter expects gas and LNG as a share of sales will increase to 74% by FY24 from 56% in FY21.

The strategy is positive, in Citi's view, offering investors a fresh look at growth. The update has minimal impact on short-medium term estimates but the broker finds the future is now more promising.

FY24 total production is expected to reach 28mmboe, supported by Otway and Waitsia stage 2. Waitsia net production is expected to increase to 5.4mmboe by FY24 from 0.8mmboe in FY21 and Otway production to 7.5mmboe from 2.8mmboe.

Morgans believes Beach can readily exceed FY24 forecasts as these excludes any exploration upside or production from projects such as Trefoil, which are still subject to final investment decisions.

The total target is below prior guidance and will entail downgrades to consensus expectations, yet Credit Suisse acknowledges it provides a more comfortable view for the market. Furthermore, the recovery in the stock over recent weeks is a reversal of an overshoot to the downside and the broker envisages more upside once Otway and Waitsia are performing in late 2022.

That said, limited catalysts over the next six months could temper enthusiasm as established production declines and the risks from new construction take precedence in the market views.

Successful gas discoveries across the Perth Basin indicate there is more upside within this acreage and Beach Energy has identified 14 prospects with potential to create a significant change in resource inventory.

There are 3-6 wells considered for drilling in the FY23 campaign so this is where Credit Suisse assesses there could be upside heading into 2023. Macquarie agrees exploration will be the driver of upside, also highlighting up to 15 exploration wells being drilled in the Western Flank in FY22.

While accepting there is some upside at current levels, Morgan Stanley questions whether the stock can outperform during a period of higher investment. Capital expenditure for FY23 is expected to be $700m-1bn. The broker holds the view that investors reward companies generating cash and returns to shareholders, with the exception being those investing in very high-returning potential projects.

Free cash flow yields are expected to increase significantly when Waitsia reaches full production so the issue is whether investors will board the stock today or consider it too early because of the execution risks.

BP Agreement

Beach has also announced an agreement with BP to cover all 3.75mt of Waitsia LNG volumes. Specific commercial terms were not disclosed yet the agreement offers flexibility about when LNG supply can commence as well as protection against any delays in construction and commissioning.

Canaccord Genuity also emphasises the offtake with BP, noting the agreed LNG price is linked to both Brent and Japan/Korea Marker and includes downside price protection.

As a result, the broker upgrades its unrisked valuation of the asset as LNG and oil prices continue to stage a substantial recovery. Canaccord Genuity had been concerned that FY22 and FY23 would be "lost years" but now describes these as "transitional".

Pricing of the agreement appears attractive to Macquarie, which notes the balance sheet is in strong shape and the corporate debt facility has been refinanced and increased to $600m.

Financing/Returns

All up, Morgan Stanley assesses the company has done a good job to re-set expectations but, in noting the upcoming investment phase is substantial, with offshore drilling in the Otway Basin followed by onshore drilling at Waitsia as well as construction, it may be some time before Beach Energy considers a higher dividend or share buyback.

Beach expects current operations will fully fund its growth targets and gearing is not expected to exceed 10% through the growth phase. Bell Potter expects free cash flow to improve from FY24 onwards which should enable more material shareholder returns as the company benefits from tightening east coast gas markets and international LNG markets.

The market may be assuming LNG prices that are too low, with Credit Suisse noting Woodmac envisages LNG spot prices could remain somewhat above US$10/MMBtu on average over the next few years.

Perth Basin, given the speculative nature and commercial uncertainties regarding gas demand in Western Australia, is assigned a 25% risk weighting to Citi's base case valuation.

The broker understands investor hesitation to pay for exploration, given the recent downgrades, but expects a growth component will creep back into the share price as positive news starts to flow in FY22, assuming success in Western Flank drilling.

Beach does not have the depth of 2C resources some of its larger peers enjoy but there is a portfolio of high-margin projects so Morgans focuses on the free cash flow yields of 16% that are expected in FY24.

RBC Capital Markets, not one of the seven stockbrokers monitored daily on the FNArena database, has re-rated Waitsia on the back of the new contract with BP, as it has removed concerns about the ability to deliver an LNG sales agreement, upgrading to Outperform with a target of $1.50.

Among others not monitored daily, Bell Potter reiterates a Buy rating with a $1.62 target and Jarden has a Buy rating, raised from Overweight, and a $1.60 target. Jarden has become more positive about some of the longer-term growth opportunities, which it did not believe were being valued by the market.

Canaccord Genuity is cautious about the production targets because of past disappointments but acknowledges the increased production forecasts and higher price assumptions, upgrading to Speculative Buy from Hold with a $1.60 target.

FNArena's database has four Buy ratings and two Hold. The consensus target is $1.52, suggesting 12.0% upside to the last share price.

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