Lundin: An Undervalued Hidden Gem With A Game-Changing Asset

Summary

• Johan Sverdrup, the game-changing asset, on track to deliver first oil in 2019.
• Cash flows swelling on low cash cost, and the company is well financed for big investments in Johan Sverdrup.
• Now a NCS pure play after spin-off of international assets.
• A 24-30 month investment horizon can deliver stellar returns.

Thesis Overview

Lundin Petroleum (OTCPK:LNDNF) has been in my research radar since February 11, 2014, and my last coverage on the stock was on September 6, 2016, when I designated a rating of “Strong Buy” for this Norwegian continental shelf focused exploration stock.

By January 3, 2017, the stock has delivered 33% returns, but correction and sideways movement ensued, and Lundin Petroleum is currently higher by 13% from September 6, 2016, levels.

The primary reason for follow-up coverage on the stock is to update investors on key developments since the last thesis and its impact on the stock going forward.

Based on the discussion to follow, I maintain a "Strong Buy" rating for Lundin Petroleum, and I see the decline from all-time highs as an opportunity to accumulate this hidden gem.

Investors should consider buying Lundin Petroleum from the Stockholm Exchange where the company trades with ticker "LUPE" and the stock trades with ample liquidity.

Update On Johan Sverdrup

In the next 3-5 years, Johan Sverdrup will be the game changing asset for Statoil (STO) and Lundin Petroleum.

The key development in the asset is that Phase 1 construction has commenced and the project is on schedule for first oil in late 2019. Lundin Petroleum has 22.6% stake in the asset that has gross resources in the range of 2.0 to 3.0 billion barrels of oil equivalent.

Johan Sverdrup valuation also needs another relook and my last coverage pegged per barrel valuation at $6.75. This was based on average analyst valuation of Johan Sverdrup at $3.5 to $10.0 per barrel of oil equivalent (based on 15 analyst reports between December 2015 and February 2016).

With more than 15 months to this estimate, the following factors are triggers to per barrel valuation upside:

1. Since the submission of phase one PDO, the capital expenditure estimate has reduced by 25% to 30%. As compared to December 2015 - February 2016 estimates, full field break-even price has also declined to $25 per barrel. This increases the attractiveness of the asset and per barrel valuation should inch higher.
2. In June 2016, Det Norske acquired BP Norge and the transaction was at $5.8 per barrel. However, from a returns perspective, Johan Sverdrup is relatively attractive. Further, I see outlook for oil as more certain than in February 2016 or June 2016.
3. Considering these two factors, I see Johan Sverdrup valuation at least in the range of $7.5 to $8.0 per barrel. Even at $7.5 per barrel, Lundin Petroleum’s stake is valued at $4.1 billion.

Further, for the first quarter of FY17, Lundin Petroleum reported operating cash flow of $46.8 per barrel with realized price at $53.7 per barrel. Considering phase 1 production estimate of 440,000boepd and 22.6% stake for Lundin Petroleum, the company’s share of production comes to 99,000boepd.

Oil is likely to be higher in FY19 and Johan Sverdrup has attractive economics. However, as a base case scenario, considering $46 per barrel as operating cash flow, the Johan Sverdrup asset is likely to deliver cash flow of approximately $1.6 billion annually.

If a detailed cash flow analysis were done and pulled to present value, the current market capitalization of $6.7 billion for Lundin Petroleum is attractive. It is only 24-30 months down the line that the company’s operating cash flow will be in the range of $1.5 to $2.0 billion and going forward, operating cash flow will potentially swell to $2.5 to $3.0 billion when Phase 2 of Johan Sverdrup is implemented.

My point is that even with ball-park estimates, it’s clear that Lundin Petroleum is currently trading at am attractive market capitalization and this undervalued gem is worth holding in the long-term portfolio.

Update On Spin-Off

Since my last coverage on Lundin Petroleum, another key development relates to the spin-off of non-Norwegian producing assets into a new company. While the international assets were not big contributors to growth, this development is worth mentioning because Lundin Petroleum currently stands as a purely Norwegian company and this focus will help the company realize higher valuations. The newly formed company, International Petroleum Corporation, will hold exploration assets from Malaysia, France and the Netherlands.

The focus on Norway is interesting for several reasons:

1. Geo-political tensions are likely to impact valuation for exploration stocks in several regions. From that perspective, the NCS region is relatively insulated.
2. Some assets in the NCS have attractive breakeven. The Johan Sverdrup Phase 1 breakeven is $25 per barrel and by Phase 2; it is likely to decline to $20 per barrel. Even with long-term oil at $60 to $70 per barrel, these assets will deliver high cash flows.
3. On June 21, 2017, Norway announced that it has opened 93 blocks for Arctic oil exploration. According to the FT news report, the Norwegian officials estimate 18 billion barrels of oil equivalent in the Barents Sea. This is likely to open new opportunities and makes companies focused in the NCS attractive.

Overall, the spin-off of international assets is a positive move and with a more focused approach, Lundin Petroleum is likely to catch the eye of investors seeking deep value in attractive assets.

Update On Production Guidance And Cash Flows

One of the points I have been making related to Lundin Petroleum in the last 1-1.5 years is that the company will deliver production and cash flows that will be sufficient to cover for Johan Sverdrup development (without sharp leveraging).

With production from Edvard Grieg and with relatively higher realized oil price, there is more room to elaborate on this point. For the first quarter of FY17, Lundin Petroleum reported production of 82,600boepd at a record low cash operating cost of $4.04 barrel. The table below gives the net-back from continuing operations for the same period.

For 1Q17, Lundin Petroleum reported per barrel operating cash flows of $46.8 and this translated into quarterly operating cash flow of $366 million.

For FY17, Lundin Petroleum expects production in the range of 75,000-85,000boepd. Considering mid-range of the guidance of 80,000boepd and operating cash flow per barrel at $45, Lundin Petroleum is positioned to close FY17 with cash flow of $1.3 billion conservatively.

With $1.0 billion available under the RBL facility and potential cash flows of $1.3 billion, the FY17 cash buffer of $2.3 billion will ensure that Lundin Petroleum is fully financed for Johan Sverdrup development. Considering the point the cash operating cost is running at record lows for the company, it is not surprising to note that Lundin Petroleum considers itself fully funded (even at $40 per barrel Brent) until first oil from Johan Sverdrup in FY19.

Concluding Words

Besides providing these updates, I wanted to highlight the stock again, which has not seen coverage on Seeking Alpha since September 2016.

Investors who can patiently hold this exploration stock for the next 24-30 months are likely to see stellar returns.

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.