There are many risks associated with the E&P companies that drill far from North America. Some of these risks include but are not limited to: inherent risk associated with exploration and development drilling, reservoir performance of producing assets not meeting expectations, expropriation of assets by foreign governments or regulatory agencies, natural disasters, local opposition, regulatory changes, political instability. For instance, the nationalization fear and the dead cow appeal in Argentina was analyzed in one of my recent articles, although this fear does not end in Argentina but it expands to several other countries around the world.
This is why, investing in an E&P company with operations in Africa or Asia or South America is riskier than investing in a producer who operates in a proven oilfield of a safe jurisdiction. If the explorer drills offshore, then the risk rises further. Nevertheless, the investors often underestimate these risks, but they put in place other speculative criteria to evaluate a potential investment.
Whenever I invest in an E&P company that operates in Africa or Asia or South America, I want it to be grossly undervalued. This may sound to many bulls a very conservative approach, but this is always working for me.
For instance, my followers know that I bought C&C Energia (CNCEF.PK) last summer. C&C Energia was on the main Toronto board. I pointed out in my first article for Seeking Alpha in late July 2012, how grossly undervalued it was at $5.7 back then. C&C Energia was acquired by Pacific Rubiales (PEGFF.PK) at almost $9 in December 2012.
Thanks to this strategy, I also did not buy Niko Resources (NKRSF.PK) at $40 in early 2012, despite the facts:
A) Niko's stock was coming from $80.
B) Several analysts and fund managers were bullish at those levels of $40-$50.
Kosmos Energy (KOS) is an oil and gas exploration and production company focused on Africa and South America. The company has producing assets offshore Ghana, as well as exploration licenses offshore Mauritania, Morocco and Suriname and onshore Cameroon.
Kosmos' production comes from the Jubilee oil field in the Tano Basin of Ghana. The Jubilee field produces currently almost 110,000 boepd and Kosmos has 24% WI. Additionally, the company is currently drilling the Sipo-1 prospect (100% WI) onshore Cameroon and the results are expected in Q1 2013.
Kosmos estimates Jubilee field production to average between 105,000 and 115,000 boepd in 2013. Kosmos' net interest in the estimated 2013 production average is approximately 25,150 boepd.
When the stock was hovering at $12.2, I explained in my article in December 2012 why the company was grossly overvalued. Kosmos' stock closed at $10.75 yesterday, which is a 12% drop from the levels of December 2012.
By the way, in the same article of December 2012, I also pointed out how overvalued Westernzagros Resources (WZGRF.PK) and Africa Oil (AOIFF.PK) were at $1.25 and $10.45 respectively. Westernzagros is at $1 and Africa Oil is at $7.10 today.
In that article of December 2012, I also was very bearish for Cobalt International Energy (CIE) at $28.38 back then. Cobalt owns acreage at the pre-salt prospects offshore Angola and in Gulf of Mexico, but it does not have any production as of today. Cobalt's stock hovers at $25.4 today, and I believe it has even more downside as analyzed in another article.
The folks who agreed with me back in December 2012, and shorted all these 4 companies including Kosmos, made a lot of money.
The Three Facts
My bearish opinion for Kosmos back in December 2012, was strengthened few weeks later by three facts:
A) Warburg Pincus LLC and Blackstone Group LP, two major shareholders of Kosmos, announced an offering of 30 million shares.
B) Several insiders including the CEO, started selling big chunks of shares in late December 2012.
C) Kosmos abandoned a discovery off the coast of Ghana because it wasn't commercially viable. This reminded the investors of the highly speculative nature of Kosmos that drills in several unproven African properties.
The Key Metrics
Apart from Jubilee, there is not any other field to support the company's production growth in 2013. In other words, Kosmos is heavily dependent on only one field which is another drawback.
The company's CapEx for 2013 totals $525 million. Even if the daily operations run smoothly in 2013, the operating cash flow for 2013 will be less than the projected CapEx which makes me believe that Kosmos will either dilute or load more debt during the next few months.
The company could sell some assets but its assets in Cameroon, Mauritania, Morocco, Suriname are not developed to get a good price tag.
In the meantime, the debt stands at $1 billion in Q4 2012 and the D/CF ratio is higher than 2. Thus, the D/CF ratio is not low enough to make a debt increase an easy decision.
2012 CF from operations was $371 million, and Kosmos has an Enterprise Value at $4.5 billion currently. This translates into an EV/CF ratio of 12.1x which is obviously another rich metric.
The company also disclosed recently that its proved reserves at the end of 2012 were only 43 MMboe and the current production is 25,000 bopd. Based on the current EV, this is a whopping $105/boe of proved reserves and a staggering $180,000/bopd.
This is why, I believe that:
A) Kosmos is very overvalued at the current levels and I am not willing to pay the current rich premium (PBV=4).
B) Dilution is coming soon and the potential buyers have to be ready for this.
Let's check out some other producers with significant offshore operations. Some of these companies also operate far from the safety of North America as Kosmos does. However, all of these companies receive Brent pricing for all or the most part of their production, and have sizable exploration targets on the table. This being said, they share several main common characteristics, but they are significantly cheaper than Kosmos:
1) Coastal Energy (CENJF.PK): Coastal has the same production as Kosmos, and its producing assets are located offshore and onshore Thailand. Coastal also holds assets offshore Malaysia, where the first oil is expected in July 2013.
This company is profitable with 2012 P/E=13, it has $100 million bank debt, $70 million cash and the EV is $2.3 billion currently.
From an EV/CF perspective, Coastal trades at a 10x multiple. With a production at 24,500 boepd (90% oil) and 149.1 MMboe proven and probable reserves (86% oil), Coastal trades at $93,900/boepd and $15.43/boe of 2P reserves.
2) EPL Oil and Gas (EPL): EPL is another profitable offshore player who has nearly the same production rate as Kosmos. The company's operations are concentrated in the U.S. Gulf of Mexico shelf, focusing on the waters offshore Louisiana.
EPL produced 21,200 boepd in Q4 2012, and it had 77.4 MMboe proved reserves in December 2012. After the latest asset sale, EPL produces approximately 20,800 boepd (70% oil) and it has 75.8 MMboe proved reserves (60% oil). With an EV of $1.7 billion currently, it trades at $81,700/boepd and $22.43/boe of proved reserves.
From an EV/CF perspective, EPL has annual operating cash flows at $230 million, and it trades at a 7.4x multiple.
EPL was transformed from a gas profile to oil by acquiring four companies within two years, and it forecasts a decent production growth for 2013. For full year 2013, the company still expects to spend approximately $300 million on its development and exploration activities.
3) Vaalco Energy (EGY): Vaalco is a Houston-based energy company with properties and exploration acreage in Gabon and Equatorial Guinea in West Africa, and the United States (Williston Basin, Granite Wash). Vaalco has also exposure to the pre-salt and pro-salt offshore prospects of Angola, holding 1.4 million gross acres there. The company's Angolan Blocks are close to Cobalt International Energy's Blocks, but the valuation gap between these two firms is huge.
This profitable oil producer has EV at approximately $300 million currently, because it holds $137 million in cash. This sizable cash hoard insulates Vaalco significantly from potential operating troubles or temporary production delays. It is also worth noting that Vaalco is debt free.
From an EV/CF perspective, Vaalco trades at a 5x multiple. With a current production at 5,000 boepd (99% oil) and 9.6 MMboe 2P reserves (99% oil) in December 2011, Vaalco trades at a low $60,000/boepd and $31.25/boe of 2P reserves. The latter key metric will most likely fall, once the new independent reserves report of December 2012 is out.
4) Talisman Energy (TLM): Talisman is a global upstream oil and gas company with operations primarily in offshore and onshore Asia-Pacific, Europe (UK, Norway), South America (Colombia) and North America. It is worth noting that Talisman has been operating for 20 years in the North Sea, offshore Indonesia, Malaysia and Vietnam.
This company produced 373,000 boepd (35% oil and liquids) in Q4 2012, excluding the asset sales. However, it has to be mentioned that the company's Asian-produced natural gas (25% of the total production) is connected to high netback natural gas markets through existing pipeline infrastructure.
Talisman had net debt at $3.7 billion in December 2012 and the EV is $16.7 billion currently. The company's proved reserves were 1,500 MMboe as of December 2011. Eventually, Talisman trades at $44,800/boepd and $11.13/boe of proved reserves.
From an EV/CF perspective, Talisman has annual operating cash flow at approximately $3 billion, and thus it trades at a 5.5x multiple.
Last but not least:
A) The income investors will likely be attracted by the company's 2.2% annual dividend.
B) The new CEO plans to make some asset sales and will most likely initiate a share buyback in 2013. In addition, he shifts the company towards oil and liquids targets, and expects Talisman to be 40% oil and liquids weighted in 2013.
Several oil plays attained >$1 billion market caps on the very possibility that their totally undrilled acreage may hold the next big discovery. However, they imploded later as the fundamentals always prevail. ATP Oil (ATPG), Delta Petroleum, GMX Resources (GMXR) are some of them, to name a few. I have never been willing to participate into this pumping game which often proves to be just another dream.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in KOS over the next 72 hours.