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Morningstar | Oil Search FVE Increased to AUD 7.00 on Improved Near-Term Oil Prices and Time Value of Money.

We increase our Oil Search fair value estimate by 6% to AUD 7.00 per share, as a result of both higher near-term Brent crude prices and the time value of money. We up our 2019 and 2020 Brent crude price forecasts by 9.1% and 9.6% to USD 68.15 per barrel and USD 67.65 per barrel, respectively, in line with the futures curve. Our long-term Brent price forecast is unchanged at USD 60 per barrel in 2021 dollars. Higher prices drive our 2019 and 2020 EPS forecasts 18% and 23% higher to AUD 0.35 and AUD 0.38, respectively.

Oil Search reported a 3% decline in first-quarter production to 7.25 million barrels of oil equivalent, or mmboe, close to our expectations. An inventory build due to unfavourable LNG shipment timing crimped sales volumes by 15% to 6.65 mmboe. Nevertheless, revenue met expectations on higher than anticipated LNG pricing, down 21% to USD 398 million. The average achieved LNG price fell 7% to USD 10.15 per mmBtu, despite the relevant prior quarter’s Brent crude price falling more sharply by 15% to USD 64.45 per barrel.

Our upgraded AUD 7.00 fair value estimate equates to a 2023 EV/EBITDA multiple of 6.1, excluding AUD 1.40 for Elk/Antelope resources and AUD 0.35 for Alaska Slope. Existing producing PNG assets comprise AUD 3.25 or just under half our fair value estimate after allocating the full AUD 2.40 in group net debt. Our assumption for expansion at PNG LNG contributes AUD 2.00 or 30% of fair value. A Papua LNG gas agreement was signed in April 2019 and we credit full value for Oil Search’s 8.0Mtpa expansion aspirations via three new 2.7Mtpa trains at PNG LNG. These will double PNG LNG’s capacity by 2023 and increase group production by 80% from a non-earthquake-impacted 29.5 mmboe base to more than 53 mmboe. We consequently forecast 15.5% five-year EBITDA CAGR to USD 2.1 billion by 2023. This is marginally ahead of Oil Search’s 2024 target, assuming it will do better.

At just over AUD 8.00, we think Oil Search shares remain materially over-valued, the market still insufficiently accounting for risks. Our fair value ascribes above average risk to equity and incorporates a 3.0% sovereign risk premium for PNG. Removing the premium would increase our fair value by 43% to AUD 10.00 from AUD 7.00, somewhat above the share price, though still to just within 3-star or Hold territory.