Company Overview: Oil Search Limited (ASX: OSH) is an oil and gas exploration, and production company with operations in Papua New Guinea (PNG), the United States of America, and Australia. The company operates various oil fields in PNG and has 29% interest in PNG LNG Project, a world-class, low-cost LNG project. OSH has roped in several successful and reputable oil and gas operators as its joint venture partner. In the United State of America, the company owns a portfolio of oil fields in Alaskan North Slope, containing many exciting exploration and appraisal opportunities with material resource upside.

OSH Details

Improving Top and Bottom Line: Oil Search Limited (ASX: OSH) is a leading energy company in Papua New Guinea (PNG) with an operating history of over 90 years. Besides PNG, the company has operations in the United States of America and Australia. The company’s strategy is to optimise the value of its existing oil and gas assets through safe, reliable and sustainable operations and enhance its organisational capabilities to deliver strategic objectives. Following the completion of a detailed and systematic review of its organisation and cost structure, the company recently implemented structural changes to make the business leaner and establish a more integrated structure that clarifies accountabilities and drives performance. Over the last three years, the company has witnessed improvement in its top-line as well as bottom-line. From 2017 to 2019, the company’s revenue and NPAT have witnessed a CAGR of 4.69% and 1.69%, respectively.

Despite the changing operating conditions caused by the COVID-19 pandemic, the company was able to report a decent production number in the first nine months of FY20. Looking ahead, OSH is focused on advancing its cost reduction and operational excellence programs in PNG and across the company. The company is also bringing in supply chain and operational efficiencies to ensure that cost reductions are sustainable. In Q4FY20, the company expects to complete its company-wide strategic review which will reset the company’s long-term strategy to redefine OSH for the future.

FY19 Results Highlights: For the year ended 30 December 2019, the company reported total production of 27.9 mmboe, up 11% on 2018, driven by the solid performance from the PNG LNG Project, partially offset by downtime following damage to the offshore liquids loading buoy and delays in fully reinstating oil field production following the 2018 earthquake. For the full year, the company posted a net profit after tax of US$312 million, down by 8% on 2018, impacted by the weaker realised oil and LNG prices and higher production costs. For FY20 the company paid a total dividend of 9.5 US cents per share, representing a dividend payout ratio of 46%. During the year, the company achieved various major milestones for the integrated three-train LNG expansion projects. OSH completed most of the pre-FEED engineering work and commercial agreements required to progress into the FEED phase of the development. During FY20, the company also made significant progress at its Alaskan business unit.

FY19 Results (Source: Company Reports)

H1FY20 Results Highlights: For the six months ended 30 June 2020, the company reported total production of 14.66mmboe, up 4% on the previous corresponding period, reflecting continued strong performance from the PNG LNG Project and the recovery of oil production to the highest level since the 2018 PNG Highlands earthquake. The Unit production costs for H1FY20 stood at US$10.38 per boe, down by 20% on 1HFY19. Due to the sharp drop in commodity prices and higher exploration expenses, the company core net profit after tax declined by 85% to US$24.7 million in H1FY20. In H1FY20, the company strengthened its balance sheet with well-subscribed US$700 million capital raising. 

Over the half-year period, the company progressed with its exploration drilling program on the Alaskan North Slope with hydrocarbon discoveries made in all three penetrations. The company also made significant progress on the early civil works for the Pikka Unit Development, including the first phase of gravel laying across the proposed footprint of the company’s future operations. As a result of reduced first-half core profit after tax and the company’s focus on preserving capital through this period of oil price weakness and volatility, OSH decided not to pay an interim dividend for FY20.

H1FY20 Results (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 29.0%. 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 0.71x reported in December 2020, 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)

September 2020 Quarter Highlights: For the September 2020 quarter, the company reported total production of 7.30 mmboe, up 7.2% on the previous corresponding period (pcp), despite the challenging conditions caused by the COVID-19 pandemic. For the quarter, the company reported total sales of 7.55mmboe, up 16.7% on the pcp. Due to the impact of the two-to-three month lag on LNG contract pricing and a higher portion of LNG spot sales, the company sales revenue during the September quarter declined by 47.6% on pcp and stood at US$189 million. Over the quarter, the company was focused on finalising the longer-term strategy for its business, to ensure it is resilient to lower oil prices and well-positioned to optimally take advantage of its world-class assets. At the end of September 2020 quarter, the company had liquidity of US$1.65 billion, comprising US$752.7 million in cash and US$895.6 million in undrawn credit facilities.

September Quarter Results (Source: Company Reports)

Director Resignation: On 20 October 2020, the company announced the resignation of Sir Mel Togolo CBE from OSH Board and relevant Board Committees. The departure of Sir Mel Togolo CBE is in line with OSH’s ongoing Board renewal and succession program.

What to expect:  OSH is committed to implementing its cost reduction and operational excellence programs across the business. To ensure capital prioritisation and discipline across the company, OSH is forming a “Pathfinder” team to drive optimal performance and resilience across all areas of the operations. The company’s Alaskan team is advancing the value and capital optimisation studies for the Pikka Unit Development to ensure that the project is resilient to lower oil prices and is easier to finance.

Following the reductions in exploration activities and rephasing of FEED activities in Alaska, the company has recently lowered its Capital investment guidance lowered to US$390 – US$460 million (from US$440 – US$530 million). For FY20, OSH expects its full-year production to in the range of 27.5-29.5mmboe. The company continues to focus on strict financial discipline, profit generation, capital prioritisation and value creation for stakeholders. OSH’s ongoing strategic review which is focused on establishing its long-term strategy is expected to be completed in Q4 FY20.

FY20 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: Over the last six months, the stock of OSH has provided a return of 22.40% on ASX and is inclined towards its 52-weeks low price of $1.807, offering a decent opportunity for accumulation. On the technical analysis front, the stock has a support level of ~A$2.49 and a resistance level of ~A$3.86. We have valued the stock using the 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 Origin Energy Ltd (ASX: ORG), Worley Ltd (ASX: WOR), AGL Energy Ltd (ASX: AGL), etc. Considering the company’s decent production performance, its cost reduction and operational excellence programs, FY20 production guidance, robust balance sheet, and current trading levels, we give a “Buy” recommendation on the stock at the current market price of A$2.950, up by 3.508% on 21 October 2020.

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

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