Company Overview: Oil Search Limited (ASX: OSH) is an energy company, involved in the exploration, development and production of oil and gas. The company was incorporated in the year 1929 to explore what is now modern-day Papua New Guinea. Since then, it has established itself as an active explorer and largest investor in Papua New Guinea and has expanded its operations in the United States of America and Australia. The company operates various oil field and has interests in several major undeveloped gas fields, including Elk-Antelope in PRL 15, and P’nyang in PRL 3.

OSH Details

Higher Focus on Cost Structure to Aid the Bottom-line: Oil Search Limited (ASX: OSH) is an energy company with world-class projects and a highly prospective exploration portfolio. As at 16 September 2020, the company had a market capitalisation of ~$5.86 billion. OSH operates various oil field and has 29% interest in PNG LNG Project, a world-class, low-cost LNG project. Lately, the company is focused on making the business leaner and establishing a more integrated structure. Over the last four years, the company has witnessed significant improvement in its bottom-line. From 2015 to 2019, the company’s net profit grew at a CAGR of 51.5%.

Four-Year Income Statement Highlights (Source: Company Reports)

Despite the challenging operating conditions caused by the COVID-19 pandemic in the first half of FY20, the company was able to report a decent production number and sales figures. However, the uncertainty surrounding the impacts of the pandemic is still there. In the current scenario, the company is emphasising on operating its production assets safely and cost-efficiently and progressing its world-class growth opportunities in PNG and Alaska when market conditions allow. Further, the company is focused on making its business leaner and establishing a more integrated structure.

In order to remain competitive with global energy industry peers, the company has introduced new cost structures and have made structural changes in the organization. With liquidity of US$1.67 billion, the company seems well-positioned to withstand a prolonged period of oil price weakness and meet ongoing liquidity needs. With other initiatives underway in 2020, including the decisive cuts in investment spending and the US$700 million capital raising, the company seems well-placed to deliver long-term value to shareholders.

FY19 Performance Highlights: For the year ended 31 December 2019 or FY19, the company reported total production of 27.9 mmboe, up 11% on FY18, driven by a strong performance from the PNG LNG Project. Over the year, the company made significant progress in the development of its three-train integrated LNG expansion projects in PNG and also made substantial progress at its Alaskan business unit. For FY20, the company reported total revenue of US$1,585 million, up 3% on the previous year, supported by the production growth.  Due to higher work programmes in the oil fields, repairs to the offshore liquids loading facility and earthquake remediation activities, the company’s total unit production costs increased by 8% to US$12.48 per boe in FY19. For FY19, the company reported NPAT of US$312 million and DPS of US 9.5 cents per share.

FY19 Financial Performance Summary (Source: Company Reports)

H1FY20 Result Highlights: For the first half of FY20, the company reported total production of 14.66 mmboe, up 4% on pcp, driven by the decent performance from PNG LNG Project. Further, the company’s total sales stood at 13.66 mmboe, up 2% on pcp. OSH’s total sales revenue stood at US$625 million, down by 19% on pcp, mainly due to the fall in oil and LNG prices due to COVID-19. For H1FY20, the company reported a net loss after tax of US$266.2 million, compared to a net profit of US$161.9 million in pcp, reflecting the sharp drop in commodity prices and higher exploration expense.

Over the period, the company strengthened its balance sheet with well-subscribed US$700 million capital raising. At the end of June 2020, the company had liquidity of US$1.67 billion, including US$831.4 million in cash and US$835.6 million in undrawn credit facilities. The company seems well-positioned to withstand a prolonged period of oil price weakness and meet ongoing liquidity needs. In order to preserve capital during the current challenging market conditions and the uncertain near-term oil price outlook, the company has decided not to pay a 2020 interim dividend.

H1FY20 Results (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 30.02%. Mubadala Investment Company PJSC and Capital Research Global Investors hold the maximum interest in the company at 9.46% and 3.19%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Metrics: For H1FY20, the company’s gross margin and EBITDA margin stood at 42.2% and 57.1%, respectively. The company’s current ratio for H1FY20 stood at 1.01x, higher than the 0.74x reported in pcp, demonstrating that the company has improved its ability to pay short-term obligations. The company’s debt to equity multiple reduced to 0.63x in H1FY20, compared to 0.68x in pcp.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Building Resilience Through Structural Changes: To deal with the issue of subdued oil prices and build resilience in the business, the company recently completed a detailed and systematic review of its organisation and cost structure and came up with measures of reducing operating and corporate overhead costs without compromising the health and safety of its staff, contractors and communities. As a result of this, the company now expects its 2020 production costs to be around US$10.50/boe (before one-off restructuring costs), compared to prior production cost guidance of US$11-12/boe.

Ongoing Strategic Review: A company-wide Strategic Review is currently underway to re-evaluate OSH’s long-term vision, strategic focus and pathway for delivering superior shareholder return. The Review is expected to simplify and de-risk the existing operations and it will ensure that a disciplined capital management approach is being followed in the company. It is expected that the Review will be completed in the H2FY20.

Change of Director’s Interest: Recently, one of the company’s Directors, Susan Cunningham, acquired 5,774 shares (indirectly) via on-market trade pursuant to a share acquisition arrangement.

Key Risks: The company is exposed to the risks of fluctuations in the oil and LNG prices. The COVID-19 pandemic has created uncertainty around the demand for energy products which could impact the prices of oil and LNG. Further, the company is also exposed to legislative and regulatory risk, political, community and other stakeholders, climate change risk and Joint venture risk.

Outlook: For the full year FY20, the company expects its total production to be between 27.5mmboe and 29.5mmboe. The company production cost for FY20 is expected to be in the range of US$9.5 - US$10.5/boe.

FY20 Production Guidance (Source: Company Reports)

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: Price to Cash Flow Multiple Based Relative Valuation (Illustrative)

Price to Cash Flow Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: The stock of OSH has corrected by 10.48% in the last three months and is inclined towards its 52-week low, offering a decent opportunity for accumulation. On the technical analysis front, the stock has a support level of ~$2.657 and a resistance level of ~$3.289. We have valued the stock using Price to Cash flow multiple based illustrative relative valuation method and have arrived at a target price of low double digit-upside (in percentage terms). For the purpose, we have taken peers like Beach Energy Ltd (ASX: BPT), Origin Energy Ltd (ASX: ORG) and Worley Ltd (ASX: WOR). Considering the decent production performance in H1FY20, particularly from PNG LNG Project, decent FY20 production guidance, strengthened balance sheet, and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $2.850, up by 1.064% on 16 September 2020.

OSH Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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