Karoon Energy: Making a real meal out of Brazil

About the author:

Author name:

By Adrian Prendergast

Job title:

Senior Analyst

Date posted:

24 February 2022, 2:30 PM

Sectors Covered:

Mining, Energy

• Another bumper result from Karoon, with the oil producer delivering strong earnings growth, heavy FCF generation, and guidance upgrades.
• 1H22 EBITDA of US$89.5m (vs MorgE US$88.7m) was in line, for a solid EBITDA margin of 48%. FY22 production/cost guidance were both upgraded.
• In the next 12 months Karoon will more than double current production while capex remains fixed given management locked in most contracts during peak COVID.
• High-margin oil producer with growth and a good balance sheet. Maintain Add.

Strong 1H22 result

Karoon delivered 1H22 underlying EBITDA of US$89.5m (vs MorgE US$88.7m). Solid cash flow was generated during the first half with operating cash flow of US$84m (vs MorgE US$76m) and FCF of US$47m.

Karoon posted underlying NPAT of US$21m (vs MorgE US$35m), with the key difference being FX impact on tax. The swing in the Brazilian real lead to non-cash adjustments to tax assets/liabilities in line with Brazil tax law. This showed up on the P&L as additional tax above our estimates. Removing the FX swing would have seen underlying NPAT of US$34.4m, in line with our US$35m estimate.

After a strong first half, Karoon has upgraded FY22 production guidance to 4.4-4.6mmbl (vs 2.5mmbl in 1H22) and reduced production cost guidance to US$28-$30/bbl (vs US$23.5/bbl in 1H22). The exceptionally low 1H22 field opex was due to some deferred expenditure which will come through in 2H22 and partially from currency weakness in the Brazilian real (opex 20% BRL vs 80% USD).

As flagged Karoon did also adjust higher its contingent liability relating to the future oil-price dependent contingent payments to Petrobras. In post-tax terms this was an ~US$121m increase (vs MorgE US$101m). 

Analysis

Despite the material steps Karoon has taken to de-risk and advance its growth strategy the market continues to only price the stock on current earnings. We base this on Karoon looking modestly undervalued if you ignore its growth profile (1H22 placing the oily on an FCF yield of 6.5% and EBITDA multiple of ~4x).

Karoon has already removed a key risk by having almost fully contracted the workovers/Patola program. This leaves us with the view that it is only a matter of time before the market starts to re-rate Karoon, as it moves to value the stock on >30kbopd production instead of its current ~13kbopd. In the absence of such a re-rating we would view Karoon as a prime takeover target.

Forecast and valuation

We have updated our forecasts for the new guidance. And to add a layer of conservatism pushed back the majority of production growth to 2H FY23.

Investment view

Despite the material steps Karoon has taken to de-risk and advance its growth strategy the market continues to only price the stock on current earnings. We base this on Karoon looking modestly undervalued if you ignore its growth profile (1H22 placing it on an FCF yield of 6.5% and EBITDA multiple of ~4x). If Karoon’s share price remains unchanged these numbers will surge to >30% FCF yield and ~2x EBITDA by FY24 (assuming a Brent oil price of US$66/bbl)

Karoon has already removed a key risk by having almost fully contracted the workovers/Patola program, securing capex. This leaves us with the view that it is only a matter of time before the market starts to re-rate Karoon, as it moves to value the stock on >30kbopd production instead of its current ~13kbopd. In the absence of such a re-rating we would view Karoon as holding exceptional corporate appeal. Karoon offers high-margin pure oil exposure.

We maintain our Add rating with a (login to view) target price.

Price catalysts 

3Q22 operating result. Workover/Patola program. M&A.

Risks

COVID related risks to oil demand drivers and operations.

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