Oil Search: Beyond PNG
Recommendation
Oil Search has been intricately tied to Papua New Guinea for 80 years. For the past decade or so, all that experience has been harnessed to build PNG's biggest resource project, PNG LNG, a two-train facility that takes gas from the Southern Highlands and processes it into LNG for export to Asia.
The first two trains (or processing facilities) of PNG LNG have been an unquestionable success - the interim results easily illustrate that.
The quest for the business now is to expand the project with additional trains and to build another project using newly discovered gas resources. That project has been dubbed Papua LNG and it has been a source of stress.
Key Points
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Solid financial results
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New growth projects at risk
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Alaskan sale could illustrate value
The changed PNG government has insisted on new fiscal terms for the project and PNG's project partners - all global heavyweights - have little patience for political shenanigans. For the likes of ExxonMobil and Total, PNG is one growth option among many. If it doesn't work, another project will take its place.
For Oil Search, expansion at PNG LNG and developing Papua LNG are key growth projects that can't be replaced. For better or worse, Oil Search is stuck in PNG. Or, at least, it has been.
Global oil search
Oil Search has made efforts to diversify. It has tried its hand exploring in the Middle East (without success) and, more recently, bought an interesting project in Alaska. That project is starting to morph into a meaningful resource and, we suspect, is being largely ignored by the market.
The Alaskan project may soon receive attention because Oil Search is selling part of its 51% project equity. That is sensible in terms of risk management and will also highlight project value clearly.
Oil Search's interim result, while good, is of minor concern because large licks of value are tied to development projects.
We are, however, interested in how much cash flow todays producing assets can generate. Assuming oil prices of US$60 a barrel and just two trains of output, PNG LNG alone ought to generate, on average, about US$900m of free cash flow per year. This could be worth between $5-6.50 a share to Oil Search. The market is attributing little value for growth projects or for Alaskan production.
2019 | 2018 | /(-) (%) |
|
Volume (mmboe) | 13.4 | 9.8 | 37 |
NPAT ($USm) | 161.9 | 79.2 | 102 |
Dividend (US cents) | 5 | 2 | 150 |
Cash flow ($USm) | 418.5 | 243.5 | 72 |
Net debt ($USm) | 2,581 | 3,048 | (15) |
First, look down
The company itself suggests that, after new projects are developed, free cash flow could grow to about US$2bn a year. If that is the case, today's price looks downright cheap. Yet we must also consider risk.
PNG, a weakly governed state, has been a graveyard for miners and drillers in the past. It demands a steep discount.
We must also consider the probability that growth projects are deferred, or that fiscal terms change. Those outcomes now appear more probable than in the past.
We are close to upgrading Oil Search. Investors with a higher risk tolerance might decide to pull the trigger now but, with the share price just above our Buy price, we're opting for patience over greed. HOLD.