Morningstar | No-Moat Beach Energy Is Driving Cash Flows with Debt all but Expunged. No Change to FVE.
We make no change to our AUD 1.80 per share fair value estimate. The negative impact of weaker near-term oil prices is offset by an increase in our midcycle EBITDA margin assumption, strong second-quarter production, and time value of money. Production and margin gains similarly insulate our fiscal 2019 EPS forecast, unchanged at AUD 0.135. But a full year’s impact of weaker price expectations does crimp our fiscal 2020 EPS forecast by 18% to AUD 0.125. Spot Brent crude currently sits near our unchanged USD 60 per barrel midcycle forecast, down 25% from the USD 80 levels prevailing around November. Other long-term assumptions are little changed, including five-year forecast cumulative free cash flow of AUD 2.9 billion to fiscal 2023, adding Otway sale proceeds.We continue to sit at a low-end 30mmboe production target by fiscal 2023, still preferring greater clarity on contributing projects before crediting Beach’s full 36 mmboe. Our fiscal 2019 production forecast is 29mmboe, at the high end of upgraded 28-29mmboe guidance. The upgrade captures better than expected first-half production, anticipated higher Bauer oil output, and delay in timing for the sale of 40% of Otway to end March, from the originally anticipated December end completion date. Original production guidance was for 25-27mmboe.
Our decision to increase our midcycle EBITDA margin assumption to 62.5% from 60% prior, acknowledges progress on cost reduction initiatives. Beach says realised synergies from the Lattice acquisition are tracking at AUD 56 million, well on target for AUD 60 million by end fiscal 2019. Further, direct controllable operating costs have been reduced by an annualised rate of AUD 8 million, with the ultimate targeted reduction of AUD 30 million per year by end fiscal 2020 increasingly in reach. We estimate AUD 30 million adds approximately 200 basis points to the EBITDA margin. Despite margin improvement, Beach lacks sustainable competitive advantage and is no-moat-rated.
Our fair value estimate equates to a little changed 2023 EV/EBITDA exit of 4.4, suitably lower than larger peer Santos’ 6.9, for example, in keeping with Beach’s lesser field life. Beach shares have weakened from October AUD 2.20 highs and at around AUD 1.80 are fairly valued.
The better than expected first-quarter operating performance leaves group net debt at a lower than anticipated AUD 331 million, down another AUD 155 million in the space of only one quarter. Net debt to equity is now just 14% and Beach is targeting a debt-free status upon completion of the Otway sale. This is a creditable outcome coming more than two years ahead of the original target date post the AUD 1.6 billion Lattice acquisition, though assisted by AUD 344 million in Otway sale proceeds. A debt-free status is commendable though advisable for a smaller oil and gas company that must reinvest to survive.
Our DPS forecast of AUD 2.0 cents for fiscal 2019 equates to a not overly material 1.1% fully franked yield, though on a payout of just 15%. It’s not clear the payout ratio will be upped once debt is expunged, but it wouldn’t surprise. Beach has had payout ratios up to 40% in the past, and on this basis, the yield might improve to nearer 3.0%. This is still not earthshattering but mere payment speaks to management confidence in the business. Beach has paid out at least something for more than 15 years straight. For now we hold to our 15% payout ratio assumption; another acquisition is always a possibility.
Strong results from the Bauer oil field underpinned a 17% second-quarter increase in production from Western Flank oil and a 6% quarter-on-quarter increase in Beach’s total oil production. The Bauer horizontal drilling campaign exceeded expectations and favourably confirms an extension to the field. Oil comprises more than 40% of Beach’s total hydrocarbon output and is an important component to company production growth aspirations.
Beach Energy is engaged in oil and gas exploration, development and production and investment in the resources industry. Co.'s operating segments include Cooper Basin, which includes oil and gas sales from Australian production; Other Australia, which includes Co.'s interest in all on-shore and off-shore production and exploration tenements within Australia other than the Cooper Basin; and International interests, which includes Co.'s interests in all areas outside Australia and oil and gas sales from Egyptian production. As of June 30 2016, Co. had total proved and probable reserve estimate of 69.8 million barrels of oil equivalent.
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