Niko Resources Ltd.
Recommendation: SPEC. BUY?
12-Month Target Price: C$12.50?
12-Month Total Return: 75.3%
Money For Nothing; And Indonesia's For Free
Friday, before market open, Niko provided capital spending guidance for
its Indian assets for F2014 and F2015, as well as an update on efforts to
raise cash from farm-outs and other asset deals. Niko has signed an
agreement to receive approximately $50 million in tranches from a former
partner in exchange for assuming the partner's future drilling obligations. The
initial tranche of $25 million is to be received by March 15, 2013.
SLIGHTLY POSITIVE. The $50 million cash Niko will receive improves
our short-term financing outlook. The amount of “money-for-nothing” Niko
has negotiated for cancelled farm-outs now stands at a remarkable $86
million. This deal will increase medium- to long-term financing risk slightly
due to the drilling obligations assumed, but we view the reduction of shortterm financing risk as the most important change. The positive impact on our
Base NAVPS drives our target price to C$12.50 (from C$12.00).
Niko's share price has declined significantly, down 29% since we downgraded
to HOLD on January 11. Since then, Niko’s only update was neutral (in our
view), and we are encouraged by indications of political support for higher
gas prices in India. We suspect the share price slide has been driven by a
technical selling or financing concerns related to an increasingly likely return
to investing in India. However, Niko's new capital spending guidance for its
Indian assets was in line with our prior expectations.
The company's tight finances remain a key risk, but we continue to believe
that Niko will have many options available to defer or divest of assets to
reduce its financial commitments, or raise additional finances, as needed.
Market valuation is now clearly ignoring significant upside potential, in our
opinion, including a world-class exploration portfolio in Indonesia. We are
upgrading our rating to SPECULATIVE BUY (from Hold).
Details and Outlook
Capital Guidance: The company's estimate of its share of planned capital spending in India vs. our estimates (that are little changed) is highlighted in Exhibit 1. The key uncertainty in estimating Niko’s near- and medium-term capital spending requirements is not in India (where most of the proposed spending is
conditional on higher gas prices being approved that would likely increase our expectations for free cash flow generation and debt capacity). Rather, it is related to the timing of potential exploration spending on Niko’s assets in Indonesia and Trinidad (and the extent to which Niko can defer, divest or farm out spending obligations).
Farm-outs, Asset Dispositions and Other Arrangements:
In combination with a prior similar payment of $36 million from Marathon to exit its farm-in obligations on
two blocks in Indonesia, the new $50 million deal brings total proceeds from cancelled farm-outs to a
remarkable $86 million of “money-for-nothing” (Niko held the blocks 100% prior to farm-outs and now owns them 100% again but has gained the $86 million). These cancelled farm-outs will increase the company’s drilling obligations and likely reduce validation of Niko’s exploration blocks by majors risk-sharing (the other party involved in the most recent farm-out cancellation is not being disclosed at this point, but given the size of the payment we speculate it is likely a company that was committed to drilling on multiple of Niko’s Indonesian blocks which would imply Repsol, Statoil or Tately). However, significant validation remains through other partnerships in Indonesia and Trinidad with ExxonMobil, Hess, and Eni, among others.
Niko remains in negotiations with various parties in regards to potential new farm-outs and asset dispositions. Considering potential proceeds from possible asset deals with potential for increased debt availability (if proposed higher gas prices in India are approved), we continue to expect Niko to have sufficient cash to fund its obligations for the foreseeable future, even though our current modeling implies a funding shortfall in F2014E in the absence of deals or new debt (Exhibit 2).
Niko trades at a significant premium on Base NAVPS relative to our coverage of International E&Ps.
However, Niko also trades below the average of other producing International E&Ps in our coverage on Fullyrisked NAVPS, and we estimate that potential conver
Justification of Target Price
Our increased target price of C$12.50 (prior: C$12.00) target is based on an unchanged 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 0.35x-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.
? Financing risk is high.
? Exploration risk is relatively high.
We 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% long-term returns on historical and expected investments, when multiple farmins 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 (despite the recent departure of some former partners).
Niko 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. However, on Fully-risked NAVPS, Niko trades at a significant discount, offering significant near- and long-term upside potential.
Potential near-term 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 or Indian government approval of higher gas prices are also key potential catalysts.