Reach Energy Bhd (NON-RATED)

Transcription

1 PP 9484/12/2012 (031413) Reach Energy Bhd (NON-RATED) INDUSTRY: NEUTRAL COMPANY INSIGHT Reaching new heights Highlights Catalysts Risks Rating Valuation More on QA. The recently released circular revealed more details on the proposal (submitted earlier) to acquire 60% stake in Palaenotol B.V., holding company of Emir-Oil, and 60% of shareholders loan for a sum of US$154.9m. Voting by shareholders would be done in the EGM on 4 th November Emir-oil, balanced portfolio with high quality, high API crude. Emir-oil current possesses 4 producing fields coupled with 2 development fields and 6 drillable prospects, pointing to high potential growth in pipeline of reserves. In addition, it also produces high-value light and sweet crude oil and possesses high condensate yield in one of its producing fields, complemented with existing infrastructure and gas evacuation facilities in place. Acquisition valuation attractive. Weak oil market has served the company well as it enables the company to be able to acquire Emiroil at bargain pricing with no abandonment charges in midterm. Excluding working capital adjustments, implied price/bbl is at US$2.9/boe, at the lower end of Kazakhstan transacted prices. The deal was also done when oil prices are at USD30-40/bbl range, 1Q16 this year. Significant upside potential. Out of 70m bbls of 2P reserves, 29.3m bbls are developed reserves of which more than half of it is producing while the remaining is shut-in, representing low hanging fruit for the company. In addition, the company has also identified 3 major value-adding measures which require minimal CAPEX: (i) LPG extraction facility (already completed by MIEH) (ii) transportation tariff reduction of USD2/bbl through pipeline tie-in (iii) well cost reduction of US$1.95m/development well. Investing in CPF to remove bottleneck. Currently, the field s production is limited to a ceiling of 6,548 bbls/day due to constraint of its leased oil processing facility. Therefore, its Vendor in the QA, MIEH, has invested in a new Central Processing Facility ( CPF ). 1 st Phase would provide processing capacity of 12,000 bbls/day while 2 nd phase (construction to commence from 2020 onwards) would ramp it all the way to 23,000 bbls/day. Direct beneficiary of oil price rally. Completion of Phase 1 CPF Entering into production asset early stage provides more upside possibility. Expansion of 2P reserves upon successful appraisal drilling of exploration wells. Oil production natural decline, oilfield operational risk, country risk. NON-RATED Positives Huge potentials in Emir-Oil. Negatives.Volatility in oil prices. Implied valuation with reference to independent valuer stands at RM1.18/share (before warrant dilution) and RM0.99/share (fully diluted). Valuation has also included primary upside potential (3 measures mentioned above). To note, full dilution of warrants may not realize in near term as warrant expiry date is at 8 th anniversary date of QA completion, indicating high time value of warrant. 24 October 2016 Price Target: Not Rated Share Price: RM0.715 Lim Sin Kiat LimSK@hlib.hongleong.com.my (603) Share price Information Bloomberg Ticker REB MK Bursa Code 5256 Issued Shares (m) 1,278 Market cap (RM m) mth avg. volume ( 000) 1,792 SC Shariah-compliant Yes Price Performance 1M 3M 12M Absolute Relative Major shareholders Reach Energy Holdings 20.0% MTD Capital 18.2% LTH 8.0% JV Swasta Sdn Bhd 3.8% Page 1 of October 2016

2 Circular on QA released In the recent circular released by the company, the proposed acquisition (worth US$154.9m) will entail Reach Energy s acquiring (i) 60% interest in Palaeontol B.V. (investment holding company & sole interest holder of Emir-Oil which in turn holds the rights in Emir-Oil Concession Block) and (ii) 60% shareholders loan currently owned to MIEH (worth US$173.1m). Figure #1 Purchase consideration (i) Acquisition of Emir Oil Adjusted Purchase consideration of the deal would be satisfied in 2 manners: (i) 85% of upfront purchase consideration paid in cash (US$120m + (25% of cash in trust net of taxes-amount payable to dissenting shareholders)); and (ii) remaining 15% to be paid within 12 months of the Completion Date (interest free). Currently, the last reported cash held in the Islamic Trust Account (Net of taxes payable) is RM759.3m, translating to RM0.759/share, (circa US$183.6m). The purchase consideration is approximately 84.4% of the money held in the trust account. Acquiring Emir Oil with cash (ii) Proposed placement of up to RM180m The proposed placement (mainly to address funding requirement arising from potential need to repurchase dissenting shares) will only take place if the proposed Qualifying Acquisition goes through (implying shareholders acceptance of 75% or higher in the upcoming EGM). There would be 2 scenarios to the proposed share placement: (i) (ii) if up to 25% of shareholders dissent, Reach would raise up to RM180m through placement to identified investors with the final size of proceeds raised to be determined by amount of shares held of dissenting shareholders post the voting process; and Under no dissenting shareholders scenario, the Company would only intend to raise up to RM68m to address short-term cash flow requirement and pay deferred consideration partially. Private placement of up to RM180m if QA is approved Issue price has yet to be set for the proposed placement (will only be done after QA). To illustrate, assuming a 15% discount to 5-day VWAMP of its shares up to 6 th May 2016 of RM0.69, issue price would be approximately RM0.59. What would happen if the QA does not go through? If the proposed Qualifying Acquisition is not approved at coming EGM (4 th November 2016), the company intends to identify another QA since it has until 15 th August 2017 to complete the new QA. Therefore, the group has to identify and execute definitive agreements for its new QA by 1Q17, to allow for sufficient timeframe obtaining the approvals of relevant authorities and shareholders. Another QA would be identified if this does not go through Page 2 of October 2016

3 More on Emir Oil The Emir Oil concession block is located in Mangystau Oblast, about 40km northeast of City of Aktau, Kazahkstan s largest sea-port on Caspian Sea coast. It is located in the prolific Mangsyhlak Bassin within the existing infrastructure, which is adjacent to other producing fields such as Zheytybay, Uzen and Tenge. The concession block is covered with 826km 2 of moderate to good quality 3D seismic data acquired and reprocessed in recent years. Figure #2 Emir Oil reserves Figure #3 Emir Oil reserves Page 3 of October 2016

4 Figure #4 Reserves breakdown Untapped reserves still high Including gas, Emir-Oil possesses 89.4m bbls worth of oil equivalent of 2P reserves with 60% stake, implying 53.6m bbls of oil equivalent entitled to Reach post abovementioned QA. There are still a lot of low hanging fruits for Reach without incurring huge CAPEX. To illustrate, out of its 70m bbls 2P reserves, 29.3m bbls are currently developed reserves of which 45% of the developed reserves are only shut-in, indicating that it would be fairly easy and cheap to ramp up its production by just doing more well completion works and workovers. Asset still under-utilized On the other hand, non-producing developed reserves (shut-in wells and behind pipe reserves which require future re-completion works) are 13.1m bbls (18.7% of total of oil) and 19.5bscf (16.8% of total of gas). This implies that the group could easily double up its production through resuming the flow of production and more well completion works which require shorter time. Page 4 of October 2016

5 Proposed plan for Emir-Oil At this juncture, crude oil produced from the Emir-Oil block is sold to both international (90% in 6M16) and domestic markets whereby produced oil from multiple wells are gathered at collection point at Dolinnoe oil field to be trucked to Mangyshlak processing plant, 34.4km away and adjacent to the train station. Limited oil processing facility Figure #5 Existing field logistics Currently, the oil processing and storage facilities are leased from Term-oil LLP amounting to circa RM0.16m/month) with processing capacity of 6,458 bbl/day storing 54,100 bbls of crude. On top of that, the current gas processing facility is owned by Emir-Oil with gas processing capacity of 5.5 MMscfd. To cater for increase in production, MIEH, vendor for the QA, has invested in construction of a new central processing facility (CPF) over 2 phases. The Phase 1 includes oil processing capabilities of 12,000 bbls/day and 21.2 MMscf of gas, scheduled to be completed by end of As per last reported date, project completion of Phase 1 stood at 70%. Vendor has invested in new CPF to increase production capacity Figure #6 Future field logistics Page 5 of October 2016

6 The new CPF would only commence operations when the 25-km oil pipeline and 35-km gas pipeline are completed in Once completed, the pipelines will be connected to truckline of KTO (connected to Aktau port for export) and KTG (gas sales) Phase 2 would only commence construction in 2019 which involves upgrading of surface infrastructure with processing capacity to be improved to 23,000 bbls for oil and 31 MMscfd for gas. It is also based on new step out discoveries for Kariman, Dolinnoe and Aksaz fields and additional production from North Kariman field. Pipelines would bring savings to transportation cost Figure #7 CAPEX profile The group s CAPEX burden in the coming years would not be substantial in comparison to years after 2018 as most of the CAPEX on Phase 1 processing facility has been borne by MIEH, whilst CAPEX for 2016 is expected to be US$28.6m for both drilling of 2 appraisal wells (Dolinoe and Yessen) and remaining spending on the CPF facility. CAPEX would be spent mainly on processing facility and drilling This would be paid for with the remaining fund in the trust account post deducting upfront consideration for QA and payment to dissenting shareholders would be a year without major spending and CAPEX from 2018 onwards would be financed from the cash flow generated from Emir-Oil subjected to movement in oil prices. To note, this CAPEX cycle only involves 2P reserves and could go higher if more 3P reserves are converted to 2P. Page 6 of October 2016

7 Figure #8 Oil production profile, RPS Figure #9 Gas production profile, RPS Oil production would be limited at cap of 5,000bbls/day (still at optimum level) from existing well stock of 50 wells up to 2018 due to oil processing capacity constraint and low oil prices. To note, this only involves producing fields, namely Kariman, Dolinnoe and Aksaz fields. In 2019, however, production would double to breach the 10,000 bbls/day level when the new CPF is up amid drilling of new wells. This level of production could be sustained for another 6 years according to RPS estimates and start to decline from 2027 onwards. New CPF will enable production to double Page 7 of October 2016

8 Figure #10 Key operating data Before accounting for taxation, Emir-oil s cash OPEX per boe amounts to USD16.08/bbl in 2015, still very much a sustainable level under the current oil price scenario. Export sales & transportation commission discount has been reduced to US$5.56/bbl in As for 6M16, cash cost/bbls is at US$17.15/bbl (including export sales & transportation commission discount of US$5.4/bbl), indicating that the field is still cash flow positive at current oil prices and cash flow buffer is still wide before turning into the negative territory. Page 8 of October 2016

9 Value-add initiatives to be done Aside from anticipated improved in oil and gas volume to be produced, the group could also tap into several low hanging fruits which would be reaped through minimal CAPEX coupled with relatively short lead time: LPG extraction From Jan 2019 onwards, Reach would be able to reap more benefits from the inclusion of LPG extraction in addition to the construction of the CPF to unlock more value from its gas which is rich in condensate and LPG yield. At this juncture, the LPG facility has been installed by MIEH as part of the CPF awaiting commissioning once the CPF is operational Further reduction in transportation tariff Upon completion of CPF in 2016 and pipelines in 2018, oil will be transported by pipeline to the Aktau terminal and thereafter shipped across the Caspian Sea to the port of Makhachkala in Russia, before onward delivery via pipeline to the Black Sea port of Novorossiysk for vessel loading. Interestingly, REACH has identified an alternative route skipping Caspian Sea shipping process by routing from the CPF to the end point, Novorossiysk export terminal, via Uzen Atyrau Samara pipeline system owned by KTO, its client. This would reduce transportation tariff by US$2/bbl from early 2019 onwards barring no unforeseen circumstances. To note, approval to construct the 25-km oil pipeline from the CPF to tie-in to the state-owned trunkline of KTO has been granted by the Kazakhstan government. Well cost reduction When drilling of development wells resumes from 2018 onwards, the company could potentially save more costs in the current depressed oil markets. Based on estimates, the company is targeting to reduce well cost by US$1.95m/development well through reduction in development drilling costs. More upsides from prospective reserves As per 1 st Jul 2016, a total 3P reserve in Emir-Oil Concession Block amounted to 146.8m boe with P3 reserves alone estimated at 57.4m boe. In addition, a number of prospects have been identified from 3D seismic interpretation. Based on independent report, the unrisked Best Estimate Prospective Resources was at MMstb of oil. Further appraisal drilling would bring about a larger 2P reserves for the group, providing further upside in terms of oil production. Page 9 of October 2016

10 Valuation Figure #11 NPV calculation by RPS, RPS Figure #12 RPS oil price assumptions, RPS Page 10 of October 2016

11 Figure #13 Valuation (RM) Base price NPV 1,502.4 No. of shares before full dilution 1,277.8 FV/share before dilution 1.18 Warrants Placement Total 2,640.8 No. of shares after full dilution 2,670.9 FV/share 0.99 According to the circular released by the company, we have arrived at FV/share of RM1.18/share (before warrant dilution) and RM0.99/share (fully diluted) based RPS base case oil price assumptions. To note, we believe full exercise of warrants are unlikely in the medium term as the expiry date of warrant is at 8 th year anniversary of QA completion date (2024 assuming this QA goes through), pointing to high time value of the warrant with more upside to be realized by warrant holder if the company manages to increase shareholder s value further through more acquisitions and new oil discoveries in area under Emir-oil. We have also included the primary upside potential which includes LPG extraction; alternative route cost savings and well cost reduction due to the high likelihood of crystallization and straightforward process execution. We have also factored in private placement price of RM0.59/share (estimate given in circular) and assumed full RM68m cash raised scenario. Full placement amount of RM180m has not been assumed as any amount of cash beyond RM68m (minimum fund raised for working capital purposes), the additional issued shares would offset dissenting shareholders portion partially, resulting in negligible share dilution impact. To note, we have only used 10% discount rate to arrive at the indicative fair value to better reflect market norm. Inside the independent valuation, production profile for both Phase 1 and 2 as mentioned has been imputed by RPS. In addition, oil price assumptions are as shown in the table above (Fig 12) for 3 oil price scenario (low, base & high). Below are the key assumptions for RPS chosen for the valuation: - 85% of total oil volume exported - Development cost of US$6.25m per well - Fixed OPEX of US$8.9m before 2019 and US$10.3m thereafter - Admin cost of US$1.6m before 2019 and US$3.2m thereafter - Variable transportation cost of US$12.8/bbl before 2019 and US$10.62bbl thereafter after completion of pipelines - Discount rate of 10% Our valuation has not factored in any upside from prospective and P3 reserves, pointing to potential upside in value if these reserves are further confirmed as 2P reserves. Page 11 of October 2016

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As of 24 October 2016, Hong Leong Investment Bank Berhad has proprietary interest in the following securities covered in this report: (a) As of 24 October 2016, the analyst, Lim Sin Kiat who prepared this report, has interest in the following securities covered in this report: (a) -. Published & Printed by Hong Leong Investment Bank Berhad (10209-W) Level 23, Menara HLA No. 3, Jalan Kia Peng Kuala Lumpur Tel / Fax Equity rating definitions BUY Positiv e recommendation of stock under coverage. Expected absolute return of more than +10% ov er 12-months, with low risk of sustained downside. TRADING BUY Positiv e recommendation of stock not under coverage. Expected absolute return of more than +10% ov er 6-months. Situational or arbitrage trading opportunity. HOLD Neutral recommendation of stock under coverage. Expected absolute return betw een -10% and +10% over 12-months, with low risk of sustained downside. TRADING SELL Negativ e recommendation of stock not under coverage. Expected absolute return of less than -10% ov er 6-months. Situational or arbitrage trading opportunity. SELL Negativ e recommendation of stock under coverage. High risk of negative absolute return of more than -10% ov er 12-months. NOT RATED No research coverage, and report is intended purely for informational purposes. Industry rating definitions OVERWEIGHT The sector, based on weighted market capitalization, is expected to have absolute return of more than +5% ov er 12-months. NEUTRAL The sector, based on weighted market capitalization, is expected to have absolute return betw een 5% and +5% over 12-months. UNDERWEIGHT The sector, based on weighted market capitalization, is expected to have absolute return of less than 5% ov er 12-months. Page 12 of October 2016