Yesterday, SapuraKencana Petroleum (SKPETRO) conducted a conference call detailing further information in regards to the proposed acquisition of Newfield Holdings Malaysian oil and gas assets. Key takeaways were: (i) 4 of its producing oil fields would be the main short-term income generator for SKPETRO; (ii) 2 out of the 4 gas fields (SK310 and SK408) could be the earliest to be developed within the next 2-5 years; and (iii) estimated net profit accretion from the oil production for the next 2-3 years is c.USD150-200m per annum. Post the conference call, we are more positive on the acquisitions. Apart from implying upsides to SKPETRO’s reserves (uncommercialised gas fields) in the longer-term, these acquired assets are also able to generate earnings and hence cash in the near-term. For our new TP, we impute an implied target PER of 27.1x (from 22x previously) on CY14 EPS of 21.4sen; to account for proforma net profits assuming a 9-month contribution of USD150m (c.RM465m) and interest costs of RM140.9m in FY15’s forecasts. This bumps our fair value for the stock to RM5.81 (from RM4.72 previously). Given the significant upside (+43%) to the current share price, we continue to advocate an Outperform call on the stock. The stock remains as our Top Pick for the sector given its integrated nature that makes it a domestic oil and gas player that cannot be ignored.

Minimal capex for oil fields (24mmbbls) that provide new term cash flows. The Newfield deal consists of 4 producing oil fields, which will be the main income generator for SKPETRO in the coming 3 years. According to management; these reserves are expected to last around 7-9 years upon infill drilling and enhanced oil recovery (EOR) efforts, and are unlikely to incur significant capex. We believe that infill drilling and EOR efforts are warranted; as based on a production rate of c.20k barrels per day, these fields could likely see depletions by the 3rd year after the acquisition.

Potential for 2P reserves upgrade from gas fields. According to management, there are 4 gas fields involved in the acquisition; of which, 2 are could be the earliest to be developed. SK310 is estimated to have resources of 1.5-3.0tcf; whilst SK408 has a 10 well drilling commitment that SKPETRO hopes to perform as soon as possible. There are no estimated resources for SK408 as yet, but management is very positive and expects the block to be similarly larger to SK310. Capex expected to be spent over 2-5 years for SK310 stands at USD1.7b (Newfield participating interest is 30%) and USD217m for SK408 (Newfield participating interest is 40%).

More debt incoming. Management looks to fund 10-20% of the acquisition (US$898m (RM2.8b)) via internal funding. The remaining 80-90% will be funded via borrowings, which are likely to be USD-denominated. We highlight that this suggests that the company’s net gearing is set to increase to 1.3-1.4x (from 1.1x as at 2QFY14 results). SKPETRO has also reverted that it is currently actively looking at restructuring its current borrowings given that it is hoping to retain its Shariah-compliant status. We understand that companies are given a grace period of 6-months to comply with the regulations.

Full-year earnings accretion of USD150-200m per annum for at least 2 years from producing assets. According to management; the estimated earnings accretion from the oil production could be c.USD150-200m per annum. This is close to the USD239m recorded in Dec-2012 by Newfield. Assuming a 9-month contribution (should the acquisition be competed by Apr-2014) of USD150m (c.RM465m) net earnings, and additional interest costs of RM140.9m, FY15 forecasts will jump by a whopping 24.7% whilst CY14 EPS will increase to 26.4sen (from 21.4sen previously). (Please refer to table below)

Risks to our call. (i) Lower-than-expected net profit accretion; (ii) Higher-than expected capex; and (iii) Lower-than-expected reserves replacement which could lead to lower-than-expected returns on acquisition. 

Source: Kenanga