Lundin Petroleum AB (OSTO:LUPE, Financial) has delivered more than 75% in the last year and the rally is expected to continue this year. Even in challenging economic conditions, the company has managed to perform well. Considering its rich asset resources, I believe Lundin Petroleum has more upside potential.
Company overview
Lundin Petroleum is an oil and gas exploration and production company with its principal focus on operations in Norway. The company has a portfolio of assets in Norway, Malaysia, France, the Netherlands and Russia. The company believes in value creation through organic growth.
Lundin Petroleum is involved in building core exploration areas in specific countries with the objective of growing with the best available technology. The company also believes in increasing its reserve base organically by converting its discoveries into reserves and production. In order to fully unlock the value of an asset so that it is clearly reflected in the stock price, the company regularly reviews and ensures the value of the asset is fully uncovered.
Lundin Petroleum has proven and probable reserves of 743.5 million barrels of oil equivalent and net production of 72,600 barrels of oil equivalent per day as of Dec. 31, 2016. Ninety-six percent of the company’s reserves and 83% of the production are from its Norway assets, of which 58% of the production comes from Edvard Greig and 20% from the Alvheim hub.
To bring things further into perspective, the company has been able to increase its production with considerable reductions in its cost of operations, resulting in improved EBITDA margins. As seen in the graph, fiscal 2016 has been a great year in terms of cost reduction and the EBITDA margin increased from 67% in fiscal 2015Ă‚ to 77% in fiscal 2016.
Edvard Greig and Alvheim asset development
On May 3, 2016, the company announced the acquisition of Statoil’s entire 15% interest in Edvard Greig oil field in PL338. The acquisition consideration is as follows:
“In consideration for the acquisition of these assets, Lundin Petroleum has today issued 27,580,806 new shares of Lundin Petroleum to Statoil ASA. In addition, Lundin Petroleum has transferred 2,000,000 shares held in treasury and issued 1,735,309 new shares to Statoil ASA in exchange for a cash consideration of approximately $64 million.”
Post the acquisition, Lundin Petroleum owns 65% working interest in one of the riches asset in Norway with OMV Norge holding 20% and Wintershall Norge holding 15%. The acquisition would further add 31 million barrels of oil equivalent of 2P reserves with 10,000 barrels of oil equivalent per day production addition.
This would result in increased production guidance to 75,000 barrels of oil equivalent per day from 65,000 barrels before the acquisition. Moreover, with the fresh issue of shares, Statoil (STO, Financial) now holds a 20.1% stake in Lundin Petroleum, which would create value in the long run by providing financial and infrastructure support to the company.
Alvheim is the second-largest contributor in terms of production with total net production of 14,400 barrels of oil equivalent per day for fiscal 2016. The field has been performing well with a very low operating cost of $5.1 per barrel of oil equivalent. The reason for the field’s outstanding performance is the infill drilling. As the oil prices are trending higher and the operating cost per barrel is considerably low in Alvheim, Lundin Petroleum is expected to benefit through EBITDA margin expansion in 2017.
Johan Sverdrup to provide considerable upside
One of the biggest growth drivers for Lundin Petroleum is its Johan Sverdrup asset. The company has 22.6% working interest in the asset with Statoil holding 40.02%. The asset is considered to be a game changer as the potential value of the asset is $3.5 to $10 per barrel of oil equivalent (based on 15 analysts' research reports between December 2015 and February 2016).
With a total gross reserve of 1.9 billion to 3 billion barrels, the valuation of the asset can be conservatively estimated to be $16.5 billion. With 22.6% working interest, the company would have $3.7 billion worth of assets to its credit. Production is expected to rise after the first phase of Johan Sverdrup, coupled with decreasing operating expenses.
A consistently strong focus on cost and operating efficiency will help the company expand its margins. Moreover, oil prices are trending higher after OPEC decided to cut down production. Assuming the price will hover around $60 a barrel in 2017, the break even of $26 per barrel will lead to considerable margin expansion for Lundin Petroleum. I believe this will also have a healthy impact on the company’s cash flow, leading to considerable operating cash flow generation post its first phase production in late fiscal 2019. Thus, I believe the company is a good long-term value investment.
Strong liquidity profile
The company has a revolving credit facility of $5 billion, of which $4.1 billion has been used up. This leaves an available credit line of $855 million. With cash and cash equivalents of $70 million and expected tax refund of $77 million, the company has more than $1 billion of available liquidity. Since Lundin has no debt maturity in the next year, the available liquidity is enough to fund capital expenditures and create value for shareholders.
Valuation
The company is trading at an attractive valuation compared to its peers. Lundin Petroleum is trading at a respective estimated 2017 and 2018 EV/EBITDA ratio of 7.2 and 6.5. This compares to Chesapeake Energy's (CHK, Financial) 2017 and 2018 EV/EBITDA ratio of 11.8 and 7.1 and Oil Search Ltd.'s (ASX:OSH, Financial) EV/EBITDA ratio of 13.5 and 9.9.
Estimated EV/Revenue of 5.9 and 5.3 for 2017 and 2018 is also impressive compared to that of Chesapeake Energy and Oil Search Ltd. Lundin Petroleum is trading at an attractive valuation despite a 75% rise in the past year, leading me to believe the company will unlock its potential gradually in the long run.
Conclusion
Lundin Petroleum has some rich asset resources to its credit. With the Johan Sverdrup oil field added to its portfolio, the company has the potential to considerably increase its production at very low operating costs. The company’s fiscal 2016 performance was impressive with a focus on operational efficiency and margin expansion. I believe this will gradually transfer into the stock price performance over the next couple of years, with more aggressive growth after production at Johan Sverdrup begins in 2019.
Disclosure: No positions in the stocks discussed.
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