Oil Search: Interim result 2015

It has taken more than 20 years but PNG is finally a major gas exporter after the PNG LNG project clocked its first reporting period at full production.

The project is, so far, operating beautifully and will contribute more than 21m barrels of oil equivalent (mmboe) to Oil Search in the full year at a production cost of less than US$9 a barrel. It is widely acknowledged to be the best new LNG project anywhere.

After only six months, the impact of the project is obvious on Oil Search's interim result: output rose 167%, revenues increased 70% and net profit rose 50% to US$228m. Despite miserable oil prices, Oil Search declared a 6 cent interim dividend, up from 2c last year.

Oil prices fell 50% to just US$56 a barrel and the company received LNG prices of just US$10 per mmbtu yet the business is still generating operating margins of 75%; operating cash flow doubled to over US$500m, reinforcing our view that current prices do not imperil PNG LNG.

Unlike peers, net debt of just US$3.4bn can comfortably be repaid and dividends sustained. There is enough gas to justify expansion of perhaps another two trains but, at lower prices, production growth is uncertain.

While we are fans of the project and hold Oil Search in high regard – no foreign miner has a better track record of working in PNG – two things concern us. Firstly, as we noted in Origin, Santos and the oil price, it is possible that oil remains at depressed levels over an extended time, lowering the value of PNG LNG.

More importantly, political instability in PNG is a humungous risk that cannot be quantified or measured. Oil Search is closer to an upgrade than ever, but it's not quite there yet.  

We estimate that, at current oil prices, PNG LNG will generate about US$700m in operating cash flow and about US$300m in profit. On top of that, there is an existing oil business that is also profitable, producing about 6mmboe a year. With a market capitalisation of $9.5bn, Oil Search is mildly cheap but not yet a bargain. The price guide is being removed while we ponder and wait. For now, HOLD.