Tethys Oil In 2018: Financial Successes, Reserves Growth

About: Tethys Oil AB (THYOF)
by: Vasily Zyryanov

Despite a noticeable drop in revenue during the oil market meltdown, Swedish Tethys Oil has been profitable every year since 2010.

Its 2P reserves have been consistently growing for seven consecutive years. 2018 2P RRR reached 177%.

With a 4.9x P/E, 2.16x EV/EBITDA, 2.88x P/OCF, and 16.3% FCF yield, shares look unjustifiable undervalued.

I regard possible exploration successes in Block 49 in the Governorate of Dhofar as essential for a shareholder sentiment.

In 2018, Oman-focused Tethys Oil (OTC:THYOF) flourished financially. Its FCF margin jumped to the highest level in 5 years, 32.5%, while operating cash flow doubled. EBITDA margin startlingly rose to 68%, while the net margin reached a breathtaking 39.5%. The highest EPS estimate was beaten by 5%. Moreover, as of April 12, the company had a phenomenal dividend yield of ~9.72%, considering both DPS and extraordinary distributions. Operations in Block 3&4 in oil-rich Oman are behind the stellar financial result and bountiful shareholder rewards, while oil-producing assets in Lithuania also slightly contributed to the top line. The fly in the ointment is the disappointing piece of news arrived on January 25, 2019. The company informed that previously planned purchase of a 2% participating interest in Block 53 (holds the Mukhaizna oil field, the largest producing area in the country, operated by Occidental Petroleum) from Total E&P Oman was canceled because partner exercised pre-emption rights. Thus, the acquisition attempt ended to no avail. However, despite the disappointment, the share price has not dropped. In my view, the reason is that the market was inspired by recuperated Brent price that drove E&P companies' stock prices higher, and the deal cancellation was left mostly unnoticed in the shadow of oil rally.

In my view, Tethys Oil has attractive equity worth researching by energy investors who prioritize robust FCF generation combined with a phenomenally low valuation: a 4.9x P/E, 2.16x EV/EBITDA, and EV/2P of 9.08x. Also, I assume that with the relatively expensive Brent Tethys could show substantial profit and FCF in Q1 FY19, which could serve as a catalyst.

The top line

Tethys Oil is a mid-sized Swedish E&P company. According to the 2018 annual report (see p. 30), the largest shareholder is Lansdowne Partners, the UK-based investment management partnership, which holds 10.1% of shares outstanding. Tethys Oil has never been unprofitable since 2012, and even the oil market slump did not take a toll on the company's profits. Most importantly, during the same period, the firm was FCF-positive. Tethys has been operating in the Sultanate of Oman since 2007 when the company acquired a stake in Block 3&4 (the operator is Oman branch of CC Energy Development S.A.L.); in 2010, together with its partners, it started production. Since then the asset has been the foundation of revenue and cash flow growth. The company is not the most significant oil player in the country; the bulk of the country's hydrocarbon production (~70%) is attributable to PDO (Petroleum Development Oman; 60% interest is owned by the Omani government, 34% by Royal Dutch Shell, 4% by Total SA, and 2% by Partex). American Occidental Petroleum is the second most significant player with around 200 kboepd produced in 2018. However, regarding acreage, Tethys Oil is among the largest concession holders in the country. Now investors closely watch operations in Block 49, which is located in the Governorate of Dhofar, adjacent to Saudi Arabia's border. The company was awarded a 100% interest in the asset in December 2017. In the case of fruitful exploration, the license might secure production upside.

In 2018, its average production from Block 3&4 (before government take) was 11,767 bpd. In 2019, that level will likely reach 12-13 kbpd (see p. 7 of the presentation). Operations in Lithuania do not bring that much. In 2018, the Gargzdai license produced only 85 bopd net to Tethys. The customer is a nearby refinery (see p.19), which purchases lifted light crude oil (an API gravity around 42 degrees) weekly. Other Lithuanian assets as the Rietavas and Raseiniai are exploration licenses. The Attila exploration license in France, the third country of operations, has expired in February 2019, but, as it was mentioned on p. 57 of the annual report, "Tethys Oil is currently reviewing further measures."

Reserves & Resources

In 2018, Tethys successfully replenished its oil reserves. The Tibyan oil discovery together with the upside revisions of the Farha South, Shahd, and Erfan fields secured 2P reserves replacement ratio of 177%; 2P reserves have been increasing for seven consecutive years. 3P reserves (Proven + Probable + Possible) went from 20 mmboe in 2013 to 35.9 mmboe in 2018. By now its proven & probable reserves concentrated in Block 3&4 amount to 25.4 mmboe, while 2C resources are 12.5 mmboe.

The balance sheet robustness

Tethys's financial position does not look vulnerable. The last year when it had a substantial amount of debt compared to equity was 2014; in June 2014 that level dropped to zero, then in September 2015 total debt rose to $8.34 million, and then disappeared again. At the end of 2018, the firm had $73.1 million in cash & cash equivalents, compared to total liabilities of only $23.8 million and total equity of $291.4 million.

2019-2021 prospects

Analysts are not confident that Tethys will be able to increase revenue and profit in 2019. I can't say that I entirely agree with their projections, as in 2019 Tethys will likely increase its production to 12-13 kboepd. Considering the lack of Brent sell-off in the best possible scenario, the top line might show positive dynamics. Also, analysts expect a gradual decline in revenue, cash flow, and net income in 2021. In particular, they forecast 2021 revenue to equal $109.8 million and net income to amount to $35.71 million. In my opinion, the main culprit of their skeptical sentiment is that the firm's critical oil-producing assets are "at peak production or in decline" (see p. 35 of the report).

Tethys Oil revenue consensus estimates. Data from S&P Capital IQ

Source: Simply Wall St. Data from Standard & Poor's Capital IQ.

In my view, the decline assumptions are not necessarily right. Certainly, analysts took into account the uncertainty if Tethys would be able to grow production from the existing asset base, or purchase producing assets from other companies. In fact, the firm has not announced any M&A ideas yet, but it probably considers the options. So, I believe the anticipated decline is not necessarily about to happen. What is more, I assume discoveries made in 2017 (the Erfan, Ulfa, and Samha areas) that will come on stream might support the output; also, possible exploration successes and contingent resources maturation could offset the decline. In this sense, the fall in revenues is not set in stone.

Shareholder rewards and FCF

The matter that will definitely arrest an attentive investor's attention is Tethys Oil's phenomenal dividend yield of ~9.72%. That level is far above the Swedish market average yield of 3.5% and the US oil & gas industry average yield of 3.37%. Here it is worth explaining that there are two types of Tethys shareholder rewards. The first one is a dividend, and the second one is an extraordinary distribution (or share redemption), which is quite similar to the share repurchase. Dividend yield adjusted for extraordinary distributions equals ~2.4% (with a share price of SEK 82.2 on April 12). Since 2014 such distributions happened three times: in 2015, 2016, and 2018. According to p. 41 of the annual report, the Board of Directors proposed to pay the dividend in two equal installments (SEK 1 each) in May and November 2019; the proposed extraordinary distribution (through share redemption) equals SEK 6 per share compared to 2018 level of SEK 4. The procedure is explained in greater detail in the document published by the company.

An unquestionable virtue of Tethys is its free cash flow. Upon cursory inspection, capital expenditures are burdensome, as in 2018 the company invested 35.4% of its revenue in oil & gas properties, or $55.8 million. Block 3&4 consumes the bulk of capex, while investments in Block 49, mainly used to finance seismic campaign, amounted to only $5.3 million. Nevertheless, the resilient cash flow covered all capital needs, and 47% ($49.6 million) of it remained as a surplus or free cash flow. In 2018, dividends and extraordinary distribution amounted to $22.6 million. Hence, FCF covered total rewards 2.2 times. It is worth mentioning that Tethys turned FCF-positive in 2011, and since then has been always generating free cash, even in 2016. Considering that 2018 revenue was $157.3 million, its FCF margin was phenomenal 30%. It is indeed not coincidental, as during the most of the year oil market sentiment allowed E&P companies to reap the benefits.

2019 capex according to the company's guidance (see p. 24 of the presentation) will likely amount to $50-55 million. Analysts expect 2019 OCF to equal ~$104.5 million. Thus, FCF could reach ~$49.5-54.5 million, more than 2x higher than possible 2019 shareholder rewards.

Possible risks worth considering

First and foremost, Tethys is a small-cap company with one vital oil-producing asset, Block 3&4, while the contribution from other assets is insignificant. In the annual report on page 35, it was mentioned that

The existing production areas Farha South, Shahd and Saiwan East are either at peak production or in decline.

So, the timely development of the Erfan, Ulfa, and Samha areas discovered in 2017 is essential to secure the production level. What is more, its future is mostly dependent on exploration successes, maturation of contingent resources, or acquisitions. Without oil discoveries, future growth will be in jeopardy. In this regard, the essential risk is fruitless drilling in Block 49. It is worth noting that the license expires in November 2020, but the exploration and production sharing agreement (EPSA) provides an option to extend it for another three years (see p. 16 of the report).


Compared to the European oil & gas industry median P/E of 10.93x, calculated by Simply Wall St., with 4.86x P/E Tethys Oil appears to be erroneously undervalued. At the same time, the company has an attractive Price-to-Book ratio of 1.1x, while the median for Stockholm-listed oil & gas companies equals 1.14x and the market median amounts to 2.51x. EV/2P reserves ratio stands at 9.08x. Also, on April 12, 2019, Tethys had an EV/EBITDA ratio of 2.16x, which is well below its 5-year average of 3.57x.

Next matter I regard worth considering is FCF yield. Tethys's 16.3% FCF yield (considering market capitalization of SEK 2,815 million and SEK/USD of 0.107888) is phenomenally high, it definitely indicates undervaluation; for broader context, I should mention that on March 27, the US-based upstream companies as Marathon Oil (MRO) and Continental Resources (CLR) have FCF yields of only 3.43% and 3.37% respectively.

Final thoughts

Tethys Oil is a financially robust company without debt. It has a spectacular FCF and trading multiples well below the industry average. At the moment I consider its equity apt for investors who stick to the tenets of value investing. However, the main risk I consider worth highlighting is the depletion of the asset base if exploration in Block 49 or inorganic growth initiatives will be fruitless. Evaporation of investor confidence could be the consequence. At the moment the market is probably waiting for discoveries or successful acquisition that will secure the production growth in the medium term. The next quite apparent risk that can hinder the company from growing the top line is the commodities market sentiment, as oil price and revenues of E&P companies are inextricably linked. In sum, Tethys's critical goals in the short term are to mature Block 3&4 contingent resources to 2P and continue exploration campaign in Block 49, as the market confidence is mostly dependent on it.

Note: Tethys Oil's ADR is illiquid. The stock exchange of primary listing is NASDAQ Stockholm; the ticker is TETY.

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.