Company Overview: Oil Search Limited (ASX: OSH) is an energy company, engaged in the exploration, development and production of oil and gas resources. The company’s operations are located in Papua New Guinea (PNG) and the United States of America. OSH operates all of PNG’s producing oil fields and holds a 29% interest in the ExxonMobil-operated PNG LNG Project, a world-class, low-cost LNG project. Notably, the company’s Alaskan portfolio contains several exciting exploration and appraisal opportunities with material resource upside. The company is currently listed on the Australian and PNG security exchanges.

OSH Details

Improving Top-line and Bottom-Line: Oil Search Limited (ASX: OSH) is an oil and gas exploration, and production company with operations in Papua New Guinea (PNG) and the United States of America. As on 18 November 2020, the company’s market capitalisation stood at ~$8.14 billion. The company’s exploration strategy is to prioritise activities that create the most value and to target those gas opportunities which have the potential to add material backfill gas for existing LNG facilities. Lately, the company is focused on ensuring that it has resilience, capabilities and financial strength to withstand a prolonged period of subdued oil prices. Further, the company intends to progress its world-class growth opportunities in Papua NewGuinea (PNG) and Alaska. During FY16-FY19, the company’s revenue and NPAT grew at a CAGR of 8.64% and 51.52%, respectively.

4-Year Financial Summary (Source: Company Reports)

In order to deal with the current low oil price scenario, OSH has significantly reduced its capital expenditure to conserve cash and has completed a US$700 million equity raising to increase available liquidity. Looking ahead, the company is focused on implementing cost management and efficiency programs to ensure the sustainability of the reduced cost base. Further, the company is focused on finalising the longer-term strategy for its business by completing the ongoing company-wide strategic review. The company is set to benefit from its world-class assets and deliver full value when conditions allow.

FY19 Results (Source: Company Reports)

H1FY20 Results Highlights: For H1FY20, the company reported total production of 14.66mmboe, up 4% on pcp. Over the half-year period, the PNG LNG Project produced at an annualised rate of 8.7 MTPA and PNG operated oil and gas production was 19% higher than pcp, with oil production up 48%, benefiting from the start-up of two development wells drilled in 2019 and improved facilities uptime. For H1FY20, the company reported total sales of 13.66mmboe, up 2% on pcp. Further, the company reported a net loss after tax of US$266 million, impacted by US$260.2 million noncash, after-tax impairment on exploration assets in PNG, Hides GTE Project and leases in Alaska. The company’s core net profit after stood at US$24.7 million, down by 85% on pcp, reflecting the sharp drop in commodity prices and higher exploration expense.

During H1FY20, the company completed a well-subscribed US$700 million (net of transaction costs) capital raise. 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. In order to provide additional flexibility during the current period of market volatility, the company has extended the expiry date of US$300 million in short-term loan facilities to 30 June 2021.

H1FY20 Results (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 28.89%. 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 EBITDA margin stood at 57.1%, higher than industry median of 36.50%. 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)

Q3FY20 Highlights: For the quarter ending 30 September 2020, the company reported total production of 7.3mmboe, up 7.2% on pcp. Notably, the company’s PNG LNG Project operated at an annualised rate of 8.9 MTPA during the quarter, taking the total first nine months of production to its highest level since the project commenced in 2014. During the quarter, the company’s operated oil assets were slightly impacted by some unplanned downtime at the Kutubu Processing Facility and Agogo Production Facility and scheduled maintenance at the Gobe Production Facility. Despite this, the company reported total sales of 7.55mmboe, up 16.7% on the pcp.

Over the quarter, the Company repaid US$60.0 million under its revolving credit facilities. As at 30 September 2020, the company had a cash balance of US$752.7 million and undrawn credit facilities of US$895.6 million.

Q3FY20 Results Highlights (Source: Company Reports)

Building Resilience Via Structural Changes: In H1FY20, the company completed a detailed and systematic review of its organisation and cost structure, focused on ensuring the company’s resilience, capabilities and financial strength against subdued oil prices. Following this, the company implemented various structural changes to make the business leaner, provide for streamlined decision-making and establish a more integrated structure.

In February 2020, the company commenced a Strategic Review to re-evaluate its long-term vision, strategic focus and pathway for delivering superior shareholder returns. The review is focused on simplifying and de-risking existing operations, ensuring disciplined capital management and capital prioritisation, and maximising returns from its projects. In line with OSH’s ongoing Board renewal and succession program, the company recently announced the resignation of Sir Mel Togolo CBE as Independent Non-Executive Director.

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: Looking ahead, OSH is focused on advancing its cost reduction and operational excellence programs in PNG and across the company. To ensure the continued focus on capital prioritisation and discipline across the company, it has established the oversight “Pathfinder” team which will drive optimal performance and resilience across all areas of the operations.

FY20 Guidance (Source: Company Reports)

Key Valuation Metrics (Source: Company Reports)

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 provided a return of 23.62% in the past three months and is currently trading below the average of its 52-week trading range, offering a decent opportunity for accumulation. On the technical analysis front, the stock has a support level of ~A$2.525 and a resistance level of ~A$6.344. 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 Worley Ltd (ASX: WOR), Origin Energy Ltd (ASX: ORG), and Karoon Energy Ltd (ASX: KAR), etc. Considering the company’s decent operational performance in Q3FY20, its cost reduction and operational excellence programs, FY20 production guidance, healthy balance sheet, and current trading levels, we give a “Buy” recommendation on the stock at the current market price of A$3.820, down by 2.552% on 18 November 2020.

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

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