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Morningstar | Beach Sells 40% of Otway Gas for AUD 344 million. The Sale Was Flagged and We Make No Change to FVE.

We maintain our AUD 1.80 per share fair value estimate. No-moat Beach has sold a 40% stake in its Victorian Otway gas project, as flagged along with recent production projections given by the company. The buyer is O.G. Energy, a wholly owned subsidiary of the Ofer Global group of companies. It will make a good partner with interests aligned, including on exploration and development. The Otway parcel includes the Otway gas plant, and the Geographe, Thylacine, Halladale, Speculant and Black Watch gas fields. The price achieved is marginally ahead of our prior fair value estimate but not sufficient to move the needle for our Beach fair value estimate overall.

We have however increased our fiscal 2020 EPS forecasts by 6% to AUD 0.14, with lower net interest expense due to Otway cash proceeds and reduced capital expenditure required, in addition to a lower AUD/USD exchange rate of 0.71. Sell-down of the Otway stake reduces Beach’s cumulative fiscal 2020-2023 capital expenditure requirement by up to AUD 450 million, though crimps production by circa 3.0 million barrels of oil equivalent, or mmboe. With Otway’s partial sell-down, Beach has revised its fiscal 2019 guidance, including circa 4% reductions in production, capital expenditure and EBITDA to 25-27 mmboe, AUD 440-520 million and AUD 1.1-1.2 billion, respectively. We conservatively sit at a low-end 25 mmboe for production and AUD 1.0 billion for EBITDA, and a high-end AUD 540 million for capital expenditure. Our AUD 0.13 fiscal 2019 EPS forecast is unchanged.

Beach has also lowered its fiscal 2023 production outlook to 30-36 mmboe, but increased its five-year cumulative free cash flow target to AUD 2.6 billion from AUD 2.3 billion, including Otway sale proceeds. We sit at a low end 30 mmboe of production in fiscal 2023, still preferring greater clarity on contributing projects before crediting Beach’s full 36 mmboe. Our five-year cumulative free cash flow forecast is consequently higher at AUD 2.9 billion.

This is in part due to lesser assumed growth capital expenditure. Cash flow projections are underpinned by strong long-term gas contracts and repricing. Despite growth plans, Beach targets a near-zero net debt position by fiscal 2020 due to strong free cash flows, in line with our projection.

Our fair value estimate equates to a marginally higher 2023 EV/EBITDA exit of 4.9 versus 4.7 prior, still suitably lower than larger peer Santos’ 6.9, for example, in keeping with Beach’s lesser field life. Beach has just 10 years proven and probable, or 2P, reserve life based on our midcycle 30 mmboe production target, and considerable work will be required to convert more resource to reserve. This is part of the grand strategy, with Beach noting its production stretch target is materially dependent upon drilling outcomes. It points to multiple avenues to replace or grow 2P reserves, including in the Cooper, Otway, Perth and frontier Carnarvon, Bonaparte and Canterbury basins. Exploration spend of around AUD 80 million per year is targeted for the next five years. But this of course won’t necessarily increase reserve life, even if successful, given the sensible intention to grow production also. Beach will begin its investment program with the Black Watch development well in late fiscal 2019, followed by the Enterprise-1 well in fiscal 2020.

We retain our no-moat rating on Beach, principally due to the sub-10 year proven and probable reserve life. Further, the primary source of competitive advantage for resource stocks stems from sustainably lower costs than peers. We don't think Beach currently qualifies on this front, though costs have declined since the Lattice acquisition. Beach is a partner in central Australian joint ventures with Santos, including the Moomba gas processing facility. Moomba is a moaty asset, but Beach’s minority 33.4% stake weakens moat arguments that apply to majority owner Santos.