Serica Energy Plc (AIM: SQZ): Initiating Coverage

Serica Energy is a ~US800 mm market cap company with >40 mboe/d production and 140 mmboe of 2P reserves in the UK North Sea. The investment case is about value and generous shareholder distributions. The strategy is to maximize the value of two key producing hubs, depending on the UK’s tax policy, to develop a third one at Buchan Horst and to grow via M&A. Over the last 2 years, the share price has been negatively impacted by the reduction in UK gas prices and fiscal uncertainty. Serica’s dividend yield is now ~15% and the share price appears to more than discount a really “worst case” for the now relative certainty that the tax regime will change. The new management that joined in 2024 is looking to maintain the strong legacy of the firm including through smart M&A across the wider North Sea and the UK. Our £2.90/sh target price reflects our ReNAV. It implies ~85% upside.

Stable production. Some tax reliefs required to unlock growth
Under a Labour government, certain tax allowances and relief on investment could be eliminated but the extent of this is not yet clear. Under a “worst case scenario”, Serica’s 2P reserves underpin stable production of >40 mboe/d until YE27 with growing net cash even after maintaining the dividend at the current level. Reinforcing commitment to the windfall tax sunset date of 2029 whilst retaining balanced capital relief would allow Serica to convert resources into reserves by sanctioning (1) the development of Buchan Horst (~21 mmbbl and ~10 mbbl/d), (2) the redevelopment of Kyle (10 mmbbl), (3) the drilling of further infill wells at Bruce (indicatively estimated to be in the region of 20 mmbbl and ~40 mmcf/d) and (4) the development of a discovery following an exploration success at Skerryvore (~36 mmboe). There are no new entrants in the UK and the regulator has increasingly demanding criteria to approve new projects. This leaves Serica in a strong position to benefit from any improvements in the environment to consolidate in the basin.

Key differentiators versus direct peers
Compared to Ithaca, EnQuest and Harbour, Serica has several advantages: (1) stronger balance sheet (YE23 net cash: ~US$100 mm, peers carry net debt), (2) lower decommissioning liabilities (US$4/boe), (3) more control on its assets and (3) lower carbon intensity.

Value build-up
Our 2P NAV, assuming a “worst case scenario” under a Labour fiscal regime is ~£1.80/sh. Under that scenario the development of Buchan would not be sanctioned, yet the aggregate shareholder distribution plus net cash at YE27 would be greater than the current market cap. With the preservation of some allowances and the EPL sunset date unchanged, our 2P NAV increases to ~£2.27-2.86/sh and Buchan would be sanctioned (+£0.13-0.35/sh). Developing Skerryvore adds £0.16-0.35/sh, Kyle adds £0.08-0.11/sh and drilling further Bruce infill wells adds £0.18-0.24/sh. Our ReNAV including the risked value of these projects is £2.88/sh.