By SiHien Goh
Endeavour International (NYSE:END) is one of the cheapest exploration and production companies with exposure to assets in the North Sea. The investment thesis is simple: Future cash flows generated can be worth as much as the entire market capitalization of the company today.
Exploration and production (E&P) companies can sometimes be priced at a discount because of the risk that wells currently being explored may not be successful in meeting expected production figures. Furthermore, even after the company successfully produces crude oil, its operating margins will largely be a factor of the prevalent crude oil price in the market. Should crude oil prices take a dive similar to the one during the financial crisis, the barrel of oil that they are producing might not fetch a price on the market that is more than the required production cost. For most E&P companies that have a heavy debt load, a narrowing margin might mean defaulting on existing debt commitments.
As an E&P stock, Endeavour has been hit hard along with the industry due to the gloomy economic growth forecast in major economies. However, the market might have failed to differentiate Endeavour from the rest of the crowd.
First, most of the company's North Sea assets are moving closer to full production. Endeavour owns a 30% working interest in the Bacchus field operated by Apache Corp. (NYSE:APA) with two out of the three wells already on line and producing. The wells began production in April and July 2012 with a combined gross production level of 13,000 barrels of oil per day (bopd), while the third well is expected to begin production as soon as the partners have gathered more information about the performance of the reservoir.
Second, Endeavour also owns a 44% working interest in the Rochelle field in the North Sea. The field is currently under development, but is expected to come online very soon as the contracted drilling rig arrived earlier than scheduled. Drilling of the first two development wells has already began and the field is expected to begin production in Q4 2012. Furthermore, Rochelle is expected to be producing natural gas sold to the U.K., and will thus be priced off the more expensive Brent crude oil (spot rate for Brent is trading at $113.70 per barrel, while WTI is only trading at $96.62 -- a 17% difference).
During the second quarter, the company also completed the acquisition of an additional 23.43% working interest in the Alba field, bringing the total working interest to 25.68%. The Alba acquisition is the first of three assets Endeavour is acquiring from ConocoPhillips (NYSE:COP) and is currently producing around 30,000 bopd (gross), essentially doubling Endeavour's North Sea production.
The other two assets that are being acquired from ConocoPhillips are the MacCulloch and Nicol fields, which are expected to close by the end of the year. Endeavour is expected to have a 40% working interest in the MacCulloch field that is currently producing approximately 3,000 bopd (gross).
With the acquisition of the three fields from ConocoPhillips and the upcoming production of existing North Sea assets, Endeavour can be expected to produce approximately 25,000 bopd by the year end. Assuming that Brent prices stabilizes at $100 per barrel (compared to its spot rate of $113.70 today), Endeavour can be expected to generate around $400 million in free cash flow in 2013 -- essentially matching the current market capitalization of the company.
Furthermore, a purchase of Endeavour stock today also means getting its shale assets in the United States for free. Because of the depressed state of U.S. natural gas prices, Endeavour's interest in the Marcellus, Haynesville, and Health shale assets are worth essentially nothing. Should natural gas prices peak up even slightly, shareholders might be in for a surprise.
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Source: Endeavour presentation on Aug. 14, 2012, to The Oil and Gas Conference in Denver.
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