Tapping Horizon’s growth pipeline

The junior resources company is walking in the footprints of Oil Search.

Summary: Horizon Oil is small in comparison with oil and gas major Oil Search, but it has a good stream of projects that have the potential to transform the company into a much larger player down the track. These include gas discoveries in Papua New Guinea, and oilfield developments in New Zealand and China.
Key take-out: Stockbrokers are tipping Horizon’s revenue will at least triple in the current year, and that pre-tax profit will more than quadruple.
Key beneficiaries: General investors. Category: Shares.
Recommendation: Outperform (under review).

It’s stretching the point to describe Horizon Oil (ASX:HZN) as a miniature replica of Oil Search, an $11 billion oil and gas producer which ranks as Australia’s 24th biggest company.

But scratch Horizon’s surface and you can see the similarities and the growth potential.

Both companies have their best assets in Papua New Guinea, and both suffer a risk/price discount because of that location, and the sometimes erratic actions of the PNG government.

The major differences between the two companies are those of size, timing and asset development.

Horizon, with a stockmarket value of $435 million, ranks as the 240th biggest company on the ASX, while its evolution is a decade or two behind Oil Search in terms of generating revenue from its PNG assets (see A gas giant in the making).

However, from a discovery perspective, Horizon is starting to track Oil Search, with its latest gas discovery in PNG’s Highlands shaping as a potential company-maker and enough to earn the stock an outperform recommendation.

The Tingu structure was described by Horizon in a report last week as a “significant gas/condensate discovery”, with the high liquids content in the gas likely to prove especially valuable.

Not widely researched because of its relatively small market value, Horizon has earned some friends in the investment banking world. Both Macquarie and UBS see the next few months as a critical time for the stock, as a number of projects in which it has an interest are expanded or move closer to a development decision.

In New Zealand, where Horizon has a 10% stake in the Maarie oilfield, production is being boosted. In China, where Horizon has a 27% interest in the Beibu Gulf oilfields, full production is close to being achieved.

PNG, however, is showing signs of becoming the flagship of Horizon’s operations, thanks to ongoing exploration success and a range of emerging development options that include domestic gas sales, “liquids stripping” from gas streams, and the potential production of LNG for export.

What analysts particularly like is the potential for Tingu to boost the commercial appeal of a gas development proposal it is studying with a number of partners, including Japan’s Osaka Gas, and for the substantial cash-generating potential of a liquids stripping project which could start operating in 2015.

Profit projections

A glimpse of what might lie ahead for Horizon is contained in the revenue and profit projections for the company from Macquarie and UBS. While the numbers are little more than the best guesses of informed analysts, they are eye-catching.

According to UBS, Horizon’s modest revenue of $US48 million in the year which ended on June 30 will effectively triple in the current year to $152 million, while pre-tax profit will rise from $US17 million to $US72 million.

Macquarie goes further, forecasting revenue in the current year of $A207 million and pre-tax profit of $A88 million.

Both brokers rate the stock as outperform/buy, with UBS setting a modest 12-month share price target of 40 cents. This is marginally higher than the current price of 33c. Macquarie is far more optimistic, tipping a target price of 60c, close to double the latest price.

What the brokers like is the combination of current cash flow from New Zealand and China and the range of development options unfolding in PNG, along with the potential for additional exploration success in that country’s Highlands.

Central to the PNG assets is a large tenement position covering 7,900 square kilometres in broadly the same region that contains the world-class gasfields underpinning the LNG project of ExxonMobil and Oil Search.

Discoveries so far by Horizon and partners (a list which includes Osaka Gas and Mitsubishi of Japan, and Talisman, a Canadian oil and gas company) are the Stanley, Ketu, Elevala and Tingu gasfields. None rate as world-class, but collectively they represent a significant asset base for a relatively small company.

Among the development options being investigated is a condensate (light crude oil) recovery project, which is waiting for government approval and would involve shipping liquids by ship down the Fly River.

The Elevala and Ketu gasfields are also the subject of a liquids extraction operation, a proposal which has been boosted by the Tingu discovery reported last week. The potential for it to be joined to Elevala could substantially increase the production potential.

Asian interest

Interest in Horizon appears to be greater in Asia than it does in Australia, with Osaka Gas agreeing to buy a 40% stake in Horizon’s PNG assets for a staggered fee of $US204 million. This comprises $US74 million in cash and $US130 million when a final investment decision is made on a possible LNG project based on the Highlands gas deposits.

In terms of hidden value, the Osaka deal implies a value of $US500 million for Horizon’s PNG assets, a number comfortably above the current market value of the company, with the producing assets in China and New Zealand tossed in for free.

The challenge for Horizon over the next two-to-three years is to find the best development route for what it has discovered in PNG. This process is likely to include a liquids shipping phase, a pipeline phase, and a small but potentially valuable LNG project in partnership with Osaka Gas, Mitsubishi and Talisman.

In its latest report on Horizon, UBS noted that the high liquids content identified by downhole testing of the Tingu structure was particularly good news. This is because, under the terms of the deal with Osaka, all liquids remain an asset of Horizon, meaning it is entitled to an ongoing 27% stake in the field, plus a bonus 18% of the liquids.

UBS said it expected a significant increase in Horizon’s oil production and revenue to be revealed in its September quarter report, thanks to rising output in China.

The next news event will be the awarding of a production development licence for the Stanley project, an event which will trigger the first ($US74 million) payment from Osaka Gas.