Description

Energean - Good long term investment opportunity with a special sit entry point !

Elevator Pitch:

We are buying a good asset run by a smart management team at attractive valuations. 

Energean is run by a good owner-operator who has demonstrated smart capital allocation (two very value accretive M&A) along with solid operational execution (development of a large gas field to production). Their core asset generates gas at very low cost and has a 17 year production runway, supplying to a region with attractive supply-demand dynamics. The recent Israel war gives an attractive entry point at 10% dividend yield (potentially 15-20% in 2-3 years as per management guidance) and a 15%+ IRR opportunity. 

Good Asset:

Energean is a East-Mediterranean gas producer that is listed on the LSE. It has oil & gas assets across Italy, Greece, Egypt and Israel. While the former 3 contribute to the current cash flows, Energean’s Israel operation is the crown jewel and contributes to 80%+ of its overall value of the firm. 

You can find the financial projections of the Israeli gas field from their 2022 CPR report below which assumes crude oil price at 70 USD/ barrel, gas price at 4.04 USD/ MMBTU and the time discounting factor at 10%, 

It is important to note that the sensitivity of the project is very low as the firm has sold up a lot of their projections at long term contracts to Israeli customers. The present value at 10% discount rate for the Israeli field in a low case scenario (crude at 63 USD/ barrel) is 5 billion USD and in a high case scenario (2% price escalation per year) is 5.95 billion USD. The low cost of production (Opex is <3 USD/ Boe) and the contracted nature of its sales results in very stable cash flow projections. 

With the Russian gas issue, the European region will continue to be an attractive gas market from a supplier’s perspective. Similarly, Israel itself has growing gas needs to support their energy transformation. With more infrastructure planned to evacuate gas from the Eastern Mediterranean fields to Europe, Energean might be able to sell some of their future uncontracted gas production to the lucrative market.  

Smart Management Team:

Capital Allocation - Energean was built from scratch through attractive M&A. They made two large acquisitions in oil bear markets (one in 2016 and the other in 2020) and also increased their stake in the Israeli field during the post COVID phase. They have also shown ability to negotiate well and restructure contracts in favour of the firm (buying back royalties on their field at an attractive price). 

First M&A deal they did was the acquisition of Prinos, which was bought for $1 million in 2007. Second M&A deal they did was to buy Karish for $48 million plus deferred payments that created the project that we have today in Israel. Third M&A deal they did was to buy Edison probably at the bottom end of the market effectively for $0 price, if you add the receivables from Egypt. So they have a clear track record of buying cheap assets and creating value for shareholders. The management is clear that they will focus all their M&A strengths only in the Eastern Mediterranean region in which they are familiar with the topography, regulations and have operational credibility. 

The management has built a 2 billion USD equity firm from scratch within 15 years despite the long oil bear market during this phase. Insiders own 20% of the firm. The CEO who is a consummate deal maker owns equity worth 180 million USD and the CFO owns 44 million USD of shares (several multiples of their yearly compensation). 

Operational Execution - The firm has shown good operational execution by building the Israel gas field to produce since acquiring it post the discovery phase. They raised the necessary financing innovatively for developing the field and also commissioned a custom built 1 billion USD FPSO which was a first in the region. The firm was able to deliver on production timelines with minimal delays despite COVID. 

The firm has also had exploratory success and has increased the Israeli 2P reserves 29% over the last 3 years. They have also reduced the production decline in their Egypt assets which created value. The firm has now embarked on a carbon capture project for their Italian asset which is expected to add value going forward. They have large exploratory licences in the gas rich Israeli region which could offer potential upsides.

Attractive Valuations:

Energean is currently available at an equity market cap of 2 billion USD. The net debt is approximately 2.75 billion USD. Hence, the net enterprise value is approximately 4.75 billion USD. The PV 10 of the Israeli operations is 5.2 billion USD and the PV 10 of remaining assets (Italy, Egypt and Greece) is approximately 600-800 million USD. 

The current debt maturity of Energean is 6 years and the weighted average cost of debt is 5.4% and is fixed for its term. The firm was able to issue 750 million USD bonds in June 2023 at 8.5% rate. So, even if we assume that the average financing cost will increase to 6.5-7% over the next few years, the post tax cost of debt is around 5-5.5%. At the current market price, implied leverage is 1.35X Debt to Equity. 

The levered equity yield at current price is attractive at 15%+ for the foreseeable future. The management has currently been paying 50 million USD/ quarter of dividends, translating into a dividend yield of 10%. The management guidance is to give a cumulative dividend of 1 billion USD between 2022-2025. They hope to step up the quarterly dividend to 100 million USD/ Quarter in the next year (as leverage comes down to 1.5X debt/ EBITDAX) and that would translate into a potential dividend yield of 20%. 

If the management is able to execute on their guidance, we should expect to receive 35% of our current price as dividends within the next 2.5 years. We are not adding any value to the management’s potential deal making capabilities in the future or the positive exploratory surprises. Hence, the Risk-Reward looks attractive at the current price. 

Conclusion:

The management has indicated in their recent regulatory filing that their asset has not faced any disruptions due to the ongoing war. The production from their gas fields continues to be stable. Their FPSO is fully insured from war related risks. 

The war risk is idiosyncratic and is not correlated with the rest of our portfolio. Israel has been a good jurisdiction with stable taxes for oil producers unlike the UK, Italy etc which imposed an ad-hoc extra tax during the high oil price environment of 2022. 

Energean has visibility for strong free cash flows over the next decade and a good capital allocator at the helm. Thus, we believe that the current war has created a special sit entry point into a good long term investment at attractive valuations. 

Catalyst

Peace, Debt Reduction, Dividend Increase