Opportunity Emerging In Beach Energy

This story features BEACH ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: BPT

-Capital could be better spent
-Net cash by end 2016?
-Potential to re-start dividends
 

By Eva Brocklehurst

Several brokers believe opportunity may be opening up in Beach Energy ((BPT)). Credit Suisse is one. The broker believes the stock is a good way to play the cost cutting that is occurring in the Cooper Basin.

Beach Energy is a junior partner (21%) in the South Australian Cooper Basin (SACB) joint venture, with Santos ((STO)) as operator. Credit Suisse calculates that with every 10% reduction in capital or operating expenditure at the SACB JV, the net present value (NPV) of Beach Energy rises 6%. The broker considers 30% savings are not beyond the realms of possibility, which would lift NPV 18%.

Credit Suisse accepts that at current oil prices, selling a stake in the SACB JV is difficult. Nevertheless, if Santos could find a way to price up, or break, the Horizon contract and the costs can be taken out it would become a saleable asset for all parties.

One aspect of the situation the broker believes sell-side models never capture is the opportunity cost entailed with being stuck with poor capital allocation. Currently, two thirds of Beach Energy's entire capex budget is spent at the JV, much of which the broker suspects is below the weighted average cost of capital (WACC). Hence, freed up capital could be better spent on delivering economic returns.

Credit Suisse finds no logic in the current under performance of Beach stock and calculates the share price is factoring in a US$57/bbl oil price in perpetuity, or US$63/bbl on producing assets. The business could look profoundly different in 12-24 months time if merger or acquisition opportunities materialise, although the broker acknowledges this is hard to quantify.

Still, with a net cash balance and a relatively defensive, albeit leveraged, play on oil, the broker sticks with an Outperform rating. Citi recently upgraded to Neutral from Sell, also noting that there are cost cutting opportunities in the SACB JV as well as pointing out the company is net cash.

Following stronger-than-expected oil prices in the June quarter, helped by robust demand and some significant supply interruptions, UBS raises near-term forecasts. The broker expects Brent to average US$51/bbl in the second half and US$60/bbl in 2017. This has a modest impact on earnings and valuations, offset partly by the increase in the Australian dollar.

Still, after incorporating the updated outlook the broker also upgrades Beach Energy to Neutral from Sell. The combination of faster-than-expected recovery in oil prices and a lower share price means the stock is trading closer to fair value.

The broker estimates the market is factoring in US$63.8/bbl for Beach, and therefore a further recovery in oil prices. Near-term oil prices have a meaningful impact on the stock, the broker contends, given its front-ended Cooper Western Flank oil production profile. Beach Energy recently moved from CPI-linked to oil-linked gas prices for its Cooper Basin sales, so UBS believes these too will benefit from higher oil prices.

The broker sees the upside risks as further rapid oil price recovery or material exploration success. The downside risks centre on a faster-than-expected rate of oil decline from the Western Flank acreage.

UBS believes the long-awaited correction in oil markets is underway, given two consecutive years of reductions in global investment and a sharp drop in US rig activity. Meanwhile, Beach Energy's balance sheet is in the shape to survive three years of oil prices below US$40/bbl. In the absence of acquisitions, the broker estimates Beach Energy's net debt would fall below $70m after three years at the above-mentioned oil price.

On the subject of a reduction in capital and operating costs, UBS believes 20% is achievable. This would increase the broker's valuation by a further 5c per share, all else being equal. The recent merger with Drillsearch has consolidated the company's opportunities in the wet gas potential of the Cooper but the main challenge confronting Beach Energy at this stage is the imminent decline in Western Flank oil output, the broker contends.

Ord Minnett recently initiated coverage of the stock with an Accumulate rating and 68c target. The main reasons outlined for the positive view include the leverage to improving crude oil prices and limited LNG contract risk.

Beach Energy generates the majority of its revenue from crude sales. Ord Minnett is positive on the underlying commodity, with Brent prices expected to increase, driven by improving global demand and reduced high-cost supply. There is also the opportunity with Beach Energy for both acquisition-led growth and capital returns.

Beach Energy has a proven track record in reserve increases. While recent history is less positive, with the broker acknowledging reserves have declined 23% since FY13, this has coincided with falling oil prices, implying economic reserves were harder to find.

Hence, subsequent increases in the oil price could reinvigorate reserve development. Ord Minnett also envisages an opportunity for the reintroduction of dividends and believes this could be a value driver of the stock.

FNArena's database has two Buy ratings and five Hold for Beach Energy. The consensus target is 66c, suggesting 2.2% upside to the last share price.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms