Lundin Petroleum Has Strong Upside Potential

Johan Sverdrup oil field likely to be long-term cash flow machine

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Jul 03, 2017
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As challenging times continue for the energy sector, investors need to be cautiously optimistic and consider exposure to quality stocks in the sector that can be long-term value creators.

One name that should be considered for the portfolio is Lundin Petroleum (LUPE, Financial) with the company having immense value creation potential in the next three to five years.

As an overview, Lundin Petroleum is a pure play in the Norwegian region with an organic growth strategy. The company has some prized assets that will be discussed in the article and currently, the company’s resource base is approximately 1.1 billion barrels. As of fiscal 2016, the company’s 2P reserves were 714mmboe as compared to 654mmboe in fiscal 2015.

From a stock price perspective, Lundin Petroleum surged by 60% in fiscal 2016 from 117.4 Swedish krona ($13.90) to 188.35 krona. The stock is lower by 14.6% in 2017; this downside is a good opportunity to accumulate this potential value creator.

Growing production

Even as the oil and gas industry faces uncertain times, Lundin Petroleum has progressed well in terms of production growth. The company’s asset in the Norwegian region has an attractive IRR, and that has allowed the company to pursue growth even as oil prices remain relatively depressed.

Just to put things into perspective, Lundin Petroleum reported net production of 21mboepd in fiscal 2015 and production surged to 59mboepd in fiscal 2016. For fiscal 2017, the company’s production is likely to be 80mboepd at midpoint of the guidance.

For the first quarter Lundin Petroleum reported production of 82.6mboepd, and this is indicative of the point that the company is on track to meet production estimates.

At the same time, the company’s operating cash has declined from $10.7 per barrel in fiscal 2015 to an estimated $4.9 per barrel for fiscal 2017.

From a long-term perspective, the important point to note is that Lundin Petroleum is well positioned to increase production in the coming years at a robust pace.

The company estimates production growth CAGR of 17% for the period of 2016 to 2022. If this holds true, Lundin Petroleum stock is positioned for strong upside.

Strong fundamentals for growth

The ambitious growth plan for Lundin Petroleum is backed by strong fundamentals. As of March Lundin Petroleum had $1.0 billion in available liquidity headroom for investments.

The company’s liquidity strength primarily comes from its growing production profile. As a result of increasing production and as oil trended marginally higher, Lundin Petroleum reported operating cash flow of $550 million in fiscal 2015 and $860 million in fiscal 2016.

For fiscal 2017, the company expects operating cash flow to be in excess of $1.0 billion and this will serve as a key source for investment in long-term game-changing assets.

Therefore, from a funding perspective, Lundin Petroleum is well positioned, and I expect the company’s leverage to remain in control considering the swelling operating cash flows.

The prized asset

From a three- to five-year investment perspective, one single asset is likely to be the big game changer for Lundin Petroleum.

Johan Sverdrup oil field is the largest Phase 1 development in the NCS, and Lundin Petroleum holds a 22.6% stake in the asset that is operated by Statoil (STO, Financial), which holds a 40.02% stake in the asset. Before talking more about Lundin and the asset, I must mention that Johan Sverdrup is the key reason for my bullish view on Statoil for the medium to long term, and the stock also trades at attractive valuations.

Coming back to Johan Sverdrup, the asset has gross resources of 2 billion to 3 billion barrels of oil equivalent and the full field break-even price is around $25 per barrel. First oil from Johan Sverdrup is expected in late 2019, and it’s expected that Phase 1 production will be 440mbopd. The full field production capacity is pegged at 660mbopd.

Considering the first phase production at 440mbopd and 22.6% stake for Lundin Petroleum, the company’s Phase 1 production share is likely to be 99mbopd.

With a low break-even and high production flow, the asset will deliver robust cash flows for Lundin Petroleum. Therefore, even if oil trades at $50 to $60 per barrel at a time when first oil is delivered from Johan Sverdrup, I expect the stock to surge higher.

Conclusion

While Johan Sverdrup will be the key cash flow machine after 2019, the company has other key assets such as Edvard Grieg that will support growth in the next two to three years. Further, the currently operated assets will be generating ample cash flows to fund the completion of work at Johan Sverdrup.

Considering the big asset in hand, strong fundamentals, assets with low break-even and assets in a region with low geopolitical risk, Lundin Petroleum is worth considering for the long term.

Disclosure: No positions in the stocks discussed.