Beach Energy: Would The Analysts Pitch This One To A Hedgie?

Summary

• Beach Energy has sold off from recent highs near $2.00.
• We think some of this is over done and when the current Covid fears abate, the stock could see a bounce.
• Longer-term, there are some catalysts that could drive the price higher.
• Patient investors with a moderate risk profile might be interested in Beach Energy for growth.
• Looking for more investing ideas like this one? Get them exclusively at The Daily Drilling Report. Learn More »

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Introduction

I worked in Australia down in Melbourne on an Exxon Mobil, (XOM) project back in 2014. It was a delightful experience, but one thing I found to be true was things are expensive there. You can't find much for an Aussie buck, which is part of the reason I was intrigued when I started looking at promising companies now selling for less than that.

Beach Energy (OTCPK:BEPTF) is the second company we've looked at in Oz recently, and came to mind as I had heard of them when I was working there. Beach became a natural to investigate as a result. Of particular interest was the low valuation being assigned to the company. A buck?!?! You can't buy a bag of crisps in Oz for a buck, but you can buy a share of Beach Energy.

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I've gotten in the habit of seeing what the analysts think when I start researching a company. After all, these guys and gals are under tremendous pressure, to up with great ideas to pitch to their bosses. The analysts are mixed with an average "overweight" rating for the stock. With an average price target of AU$1.57 and a high of AU$1.97, a USD upside of 10-30% is implied.

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It's not entirely clear to me what "Overweight" means. If I was a joker I'd crack-wise about it needing to shed a little weight, but I am a serious financial blogger, and will steer clear of any shenanigans of that type. I am relatively sure it means your portfolio should be overweight Beach Energy. Suggesting to me they perhaps are pitching this Aussie microcap to risk-tolerant hedgies. Although we check what the analysts say, we do our own independent investigations around here. So let's try and figure out if Beach is properly valued at current share prices, or if we might expect a run higher in a reasonable time frame.

The thesis for Australian Energy companies

Australia still burns coal for 75% of its energy needs. Even though it has a lot of coal and coal is cheap, it has become unpopular in recent times. Australia also has a lot of gas and in addition to its renewables focus will rely on its reserves for power generation. Thanks to the massive gas projects in NW Oz, Chevron's (CVX) Gorgon, for example, the North West is topped up with ample gas through the mid-25s. The East Coast of the country has a present shortfall that's expected to widen as the decade wears on.

Beach presentation

Energy companies in Oz are also positioned to do well-exporting LNG to the rest of Asia, as noted in our recent research on Woodside Petroleum.

Australia is a natural player in the Asian-directed LNG trade. It is a member of the ASEAN (Association of South Eastern Asian Nations) which gives companies there some preferred access to member nations' markets.

Australian pricing is higher than U.S. gas pricing by several multiples. Part of the reason is that their northwest shelf is one of the most remote areas of the world, and it costs a lot to build here. This has the potential to reward producers that can control their costs.

So, there you have it. Growth in domestic needs and export opportunities present an attractive picture to prospective investors.

There is also the growing realization in government "Down Under" that renewable energy requires backups that rely on gas. As noted in the linked Guardian article, Oz is building a 660 MW gas-fired electric plant for peak load and over-load requirements. Other gas-fired plants are being built by private utility providers for the same reason.

The thesis for Beach Energy

Beach participates in all the major gas plays in Australia, but has particular exposure to the East coast as can be seen in the graphic below. Through their Cooper Basin, Otway offshore, and Bass Basin assets Beach produces about 15% of that state's gas. Through their Western Flank assets they produce liquids, but recently downgraded reserves on subpar well performance from the horizontal wells be used to tap the sandstone structure.

A common culprit to field premature decline is improper adjustment to changing field conditions as the asset matures-gains more wells. I've no idea if this is the case here and there could be other reasons. But, we've seen this "learning curve" in the Permian as wells placed too close to existing wells, began to "harmonize," leading to poor performance.

The fix for this is a reservoir study called a "pressure transient analysis," and a new well or series of wells to remap the reservoir for optimal well path placement. That being the case, I view this condition as being transitory. What was removed in the way of valuation due to underperformance, can be restored with better performance. This comment from management is supportive of my thesis above-

What we've seen in the past few months is a higher-than-expected well interference from the McKinlay drilling on the Namur and McKinlay existing producers and, as a result, faster decline rates.

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Beach presentation

With the FID with partner Mitsui, Beach is poised to become an LNG exporter through existing NWA LNG facilities in the next couple of years. Although there is substantial capex outlay associated with this FID, it can be considered "advantaged" by virtue of the connection to NWA's massive LNG infrastructure. Beach is in the process of looking for a buyer of its estimated 0.75 mpta LNG cargo. At $8.5 per mbtu for contract pricing, and much higher as noted in the slide below for spot pricing, this will add a minimum of AU$ 450 mm in revenue to Beach annually.

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So there you have it. An Aussie operator with a wide footprint across the country, and a catalyst for significant growth just over the horizon. This is normally a great time to buy into a company.

Financial metrics for growth

Beach generated AU$296 mm OCF in 2020 from which it has funded capex for various projects, along with its revolving debt facility. It repaid AU$100 mm of that in 2020 to keep liquidity high, and less cash on the books has net debt of AU$ 46 mm. Its margins on sales are impressive with an EBITDAX margin of 63%, and provide a source for optimism about future revenues.

Catalysts for growth

The second half of 2021 should be interesting for Beach. They've pulled the lever on the Waitsia gas project, and well just have to wait for that to come online as previously discussed.

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Enterprise gas discovery in the Otway basin

We noted that the east coast market is underserved for gas. The Enterprise discovery will be followed by a FEED study that should deliver gas to the existing Otway gas plant by 2023. This discovery meets the company's target for their 5-year production forecast for Otway. It also derisks targets adjacent to the Enterprise well. Beach has begun their own campaign to increase gas reserves with a 6-well program as noted in the Forward activity section of the slide below.

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Trefoil

Another short-term catalyst that could be impactful on the stock is the Trefoil development. This asset part of a recent acquisition from Mitsui is undergoing FEED to extend the life of the Yolla platform.

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Risks

The company is expanding on a number of fronts as discussed. This is being supported by increased cash flow from recovering oil and gas prices. If that trend weakens, the company could find itself exposed as capital costs outstrip cash flow.

Your takeaway

Beach has shown the capacity to grow through acquisition (Lattice Energy in 2018), a move that doubled reserves and production. It has also grown organically with reserves climbing from internally generated prospects over the years. This has been done without compiling a huge pile of debt, with is noteworthy and undoubtedly helped the company survive the downturn last year.

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Beach has a strong domestic gas business and the export of the Waitsia gas as LNG will provide a further lift in the near term, increasing current revenues as much as 20% by itself.

Beach is now trading at roughly 4X EV/EBITDA which is a pretty low valuation due in no small part to its low debt. As these new projects we've identified as potential catalysts come on line the market should become kinder and give Beach a higher multiple. The growth target of tripling production to ~37 mm BOE by 2025, would almost make this automatic taking cash flow from the present ~AU$300 mm to close to AU$ 1.0 bn.

In summary, I think Beach presents a compelling investment case at its current price for investors who have time horizon of 2-3 years. In that time we could see a price for the company in the $5.00 range.

Come to think of it, anybody knows a hedgie?

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.