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Morningstar | We Increase our FVE for No-Moat Beach to AUD 2.25 with Potential for Further Gains Remaining. See Updated Analyst Note from 08 Jul 2019

We increase our fair value estimate for no-moat Beach Energy to AUD 2.25 per share from AUD 1.95, due to a lower AUD/USD exchange rate of 0.70, the time value of money, and after increasing our midcycle domestic gas price forecast to AUD 7.15 per million British thermal units, or mmBtu. We think our prior forecast of AUD 6.50/mmBtu was too pessimistic. We think a higher incentive price is needed, given the export linkage and legislative barriers. Our fair value equates to a fiscal 2023 EV/EBITDA exit of 4.8, assuming 8.1% five-year EBITDA CAGR to AUD 1.1 billion by fiscal 2023. In addition to an unchanged USD 60 Brent crude price forecast in 2022 dollars, we still assume a 60% increase in group production to 30.6 million barrels of oil equivalent, or mmboe, by fiscal 2023. This is toward the lower end of Beach’s five-year production target range of 30-36 mmboe and a better result could bring upside to our fair value estimate. However, given associated expansionary capital expenditure required and limited field lives based on the company’s current reserve/resource position, we determine the fair value impact of increasing production to a high-end 36 mmboe is limited.

More material value add is likely through reserve additions to extend the production and the cash flow tail. At June 2018, group proven and probable reserves stood at 313 mmboe, equivalent to just over 10 years life at prevailing 30 mmboe annualised production rates. Our model credits somewhat more, an average 15 years life, anticipating exploration success and conversion of resources to producible reserves. Increasing life by a further five years would increase our fair value estimate by around 20% to AUD 2.75. This is naturally a focus for Beach and the company targets a greater than 100% reserves replacement rate for the five years to fiscal 2023. Success with that goal would extend life by at least five years.

There is also another potential area of upside for our fair value coming via the domestic gas price. Our midcycle domestic gas price forecast for Beach is upgraded to AUD 7.15/mmBtu in 2022 dollars, but still below fiscal 2018 levels in real terms. A downside scenario might be a material opening up in drilling and fracking, though unlikely given community objections.

In the 10 years to fiscal 2018, Beach achieved an annual average 3.5% increase in gas price from AUD 4.95/mmBtu to AUD 6.90/mmBtu, marginally beating inflation. But the spot domestic gas price remains above AUD 8.00/mmBtu, after recently threatening AUD 10.00 levels. Beach’s lower achieved prices reflect less favourable legacy contracts, in addition to more recently Lattice’s pricing arrangements. But by calendar 2022, 80% of current volumes should have been re-priced to prevailing market prices. This process recently began and will sequentially play-out over the next four years.

Our AUD 7.15/mmBtu midcycle domestic gas price clearly anticipates some of the heat coming out of the domestic market. It is derived from our USD 8.40/mmBtu Asia LNG price forecast, less liquefaction and freight costs, and with a further 15% domestic market discount. Spot Asia LNG prices have more recently trended to below USD 6.00/mmBtu, and domestic gas prices are highly politicised. But were the spot domestic gas price to remain above AUD 8.00/mmBtu in real terms, it could represent a further approximately 15% or AUD 0.30 boost to our fair value estimate, all else equal.

Given fair value sensitivity to field life, it is encouraging exploration, appraisal and development activities in the Cooper and Otway basins are focused on bringing more gas to the east coast market. In pursuit of a greater than 100% reserves replacement ratio, the Moomba South gas appraisal program in the Cooper Basin join venture was successful and rigs are secured to accelerate Cooper Basin drilling and unlock on- and offshore Otway Basin potential. For now we assuming five years life beyond reserves is sufficient credit. But Beach has 2C contingent resources of 207 mmboe of which 152 mmboe is conventional gas and liquids.