Niko Resources Ltd. (NKO-T) C$8.34
Waiting for Gas Price Clarity (or Exploration Success)
Yesterday before markets, Niko Resources Ltd. (NKO-T) reported financial and operating results for Q3/F13 (ending December 31, 2012).
Recommendation: HOLD Unchanged
12-Month Target Price: C$12.00
12-Month Total Return: 43.9%
Details and Outlook
Financial Results: Niko reported cash flow of $26.9 million that missed our $28.2 million estimate due to lower-than-expected production and realized prices combined with higher-than-expected cash taxes and a foreign exchange loss. CFPS of $0.47 beat our $0.44 estimate (consensus was at $0.51) because we had assumed a dilutive impact of previously outstanding convertible debentures that we have now removed from our modeling. Details of Q3/F13 results versus our expectations are presented in Exhibit 1.
Operations and Production Guidance Update: Sales volumes for Q3/F13 declined to average 145 mmcfe/d (from 173 mmcfe/d in Q2/F13), due to natural declines and scheduled maintenance in India and temporary curtailment of production from one well in Bangladesh. Guidance for Q4/F13 sales is 130 mmcfe/d. For fiscal 2014, Niko is currently working with its partners to finalize workover and development plans and expects to provide volume guidance once these plans have been finalized. Assuming normal progress, we expect this guidance to be issued during March.
Gas Prices Likely Moving Higher in India – Will Reserve Additions Follow?
Niko management highlighted its view that the business environment in India appears to have improved with the release of a government-appointed committee's report on domestic gas pricing and the restart of planned development and exploration activities on the D6 block. In December, the Rangarajan Committee published its report that included a recommendation on a gas-pricing mechanism. This recommendation is currently being reviewed by the Government for approval. Based on current inputs into the pricing formula, Niko estimates the price for natural gas sales from the D6 block would increase to approximately $8-$8.50/mmbtu compared with $4.20/mmbtu currently. We believe that the proposed formula has significant potential to result in prices above $8.50/mmbtu, depending on evolution of global benchmark pricing for oil and gas. The field development plan for an additional development area in the D6 block was submitted in January 2013 and the plan for a development in the NEC-25 Block is to be submitted by March 2013. With field development plans submitted and increased clarity on future gas prices for the developments, Niko expects to book a substantial portion of its contingent resources as reserves, effective March 31, 2013. We agree that there is a logical sequence of events that is reasonably likely to unfold over coming months leading to a significant increase in reserves (Niko typically issues its year-end reserves update in June). However, with higher gas pricing still requiring final government approval and conclusion (or adjustment) of sales contracts, we prefer to wait to see some critical steps taken in a timely manner (before assuming reserve addition will happen in June). That said, we note very large upside potential to our Base NAVPS. Based on our current modeling, we estimate our Base NAVPS would increase from C$1.54/share to over C$25/share, if all of Niko’s contingent resources in India were booked as 2P reserves (assuming gas prices as proposed by the Rangarajan Committee). Financing risk: We have reduced our near-term production and cash flow expectations due to slightly lowerthan- expected recent production. However, our DCF valuation of reserves and resources is little changed. Our perception of financing risk is also little changed. We assume that Niko will be fully drawn on its $100 million borrowing base by year-end fiscal 2014 (March 31, 2014, see Exhibit 2), and will require additional funds from financings or divestments unless capital spending is reduced below our current assumptions.
Niko trades at a significant premium on Base NAVPS relative to our coverage of International E&Ps. However, it also trades below the average of other producing International E&Ps in our coverage on Fullyrisked NAVPS.
Justification of Target Price
Our unchanged C$12.00 target is based on a combination of 0.85x Base NAVPS and 0.35x Upside to Base NAVPS. The 0.35x Upside multiple is significantly below the average we currently use for other International E&Ps due to our view of financing risk and very long lead times to production and development associated with deepwater offshore exploration assets. For other International E&Ps, we currently use a range of 0.40x- 0.90x in terms of our multiples of Upside to Base NAVPS.
Key Risks to Target Price
Key risks associated with our target price include business risks of the company and industry, including but not limited to: loss of key employees, drilling success, volatile commodity prices, operating costs, capital cost overruns, product supply and demand, financing/access to capital, government regulations, legislation, unexpected changes in contract/fiscal terms, asset expropriation, royalties, taxes, exchange rates, interest rates, and environmental and weather concerns.
The key near-term risks specific to Niko are:
Higher-than-average geo-political, fiscal and legal risks: Niko is in dispute over taxation and other
payments with both Indian and Bangladeshi authorities, and has been fined for attempted corruption
under Canadian law. We have generally assumed that any future legal rulings will be in Niko’s favour or
negligible to valuation.
Financing risk is relatively high.
Exploration risk is relatively high.
We view Niko’s Q3/F13 results update as relatively neutral. As a result, we believe that relative valuation has improved slightly thanks to recent share price weakness (including an 8% sell-off yesterday).
However, Niko still trades at a significant premium on Base NAVPS and its ability to finance its commitments beyond 2013 is uncertain (in our view), while exploration and political risks are high. We maintain our HOLDrating.
That said, on Fully-risked NAVPS, Niko trades at a significant discount. We still believe that Niko has a
world-class exploration portfolio (particularly in Indonesia) and valuable contingent resources in India and
Trinidad. Our valuation of long-term exploration potential implies the company achieving below 15% longterm returns on historical and expected investments, when multiple farm-ins by larger companies imply that those companies see potential for significantly higher returns on a majority of Niko’s Indonesian blocks. Multiple deals appear to indicate that major oil companies could be interested in Niko or its assets, suggesting management should have options available to avoid another cash crunch.
Potential catalysts include results from Niko’s third deepwater exploration well in Indonesia (Cikar-1)
expected in late March, as well as the MJ-1 well in India. Potential asset sales that help to reduce financial
leverage could also cause a positive market reaction. Possible government approval of higher gas prices in India is also a key potential catalyst. In our opinion, gas pricing in India has significantly more upside potential than downside risk.