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Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Genesis Energy<br>Kupe&nbsp;Strategic Review a Positive</h2>
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<p><strong>OUTPERFORM</strong></p>
<p>Genesis Energy (GNE) has announced it is undertaking a strategic review of its 46% interest in the&nbsp;Kupe&nbsp;oil and gas field. The review will determine whether GNE retains or sells its stake in the field. The review outcome is expected to be announced in mid 2021, and we consider a sale is the most likely outcome of the review as the strategic need for GNE to own&nbsp;Kupe&nbsp;will diminish over time. We view the decision to undertake a strategic review as a positive.&nbsp;</p>
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<h3>Strategic review a positive move</h3>
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<p>GNE is effectively deciding whether to sell its&nbsp;Kupe&nbsp;stake or not.&nbsp;There are a number of reasons why&nbsp;selling&nbsp;Kupe&nbsp;now is attractive for GNE, including 1) firm gas prices as a result of the restricted&nbsp;Pohokura&nbsp;supply,&nbsp;2) exiting&nbsp;Kupe&nbsp;before it enters its decline phase, and 3) selling before further exploration and drilling, which would change&nbsp;the risk and return profile of the investment. In addition, selling&nbsp;Kupe&nbsp;will&nbsp;likely improve&nbsp;GNE's&nbsp;ESG perception.&nbsp;As part of the review, GNE will also be considering its capital structure, although somewhat surprisingly in our view this will not include a review of&nbsp;GNE's&nbsp;dividend policy.</p>
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<h3>Impact on earnings and dividend sustainability</h3>
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<p>GNE has indicated that the sale of Kupe will not impact its dividend. However, with Kupe producing between 25%–30% of GNE's annual EBITDAF, stripping out Kupe will have an impact on GNE's ability to maintain its dividend profile. We are forecasting FY21 free cash flow of 18.7cps, which would fall to 13.4cps without Kupe earnings, well below GNE's FY20 17.2cps dividend. In simple terms, the reduction in interest costs from selling Kupe is materially less than Kupe's cash flow contribution. However, GNE's dividend reinvestment plan and future earnings growth (due to the lower contracted gas prices) should ensure debt levels stay at manageable levels.</p>
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<h3>What could&nbsp;Kupe&nbsp;sell for and who are the potential buyers?</h3>
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<p>We estimate that Kupe could sell for between NZ$250m and NZ$400m. The net book value of Kupe on GNE's balance sheet is ~NZ$227m (22cps). Our Kupe DCF value is NZ$286m (27cps) — however, this does not include any exploration upside. The two recent Kupe transactions are GNE acquiring NZO's 15% stake and NZO acquiring Mitsui's 4% stake, both with an effective date of 1 Jan 2017. Those transactions imply a 46% Kupe stake of between NZ$402m to NZ$515m as of January 2017. Since then, gas prices have firmed, oil prices and interest rates have fallen, and we estimate GNE's Kupe cash flows from the past 3.5 years is ~NZ$300m. Estimating the possible sale price is challenging as GNE may alter the gas contract price for the 46% it is selling.</p>
<p>Potential buyers of Kupe appear limited. Todd Energy and OMV are the largest gas producers by a significant margin, potentially raising Commerce Commission issues. That only leaves three other gas producers; Beach Energy, NZ Oil &amp; Gas and Greymouth Petroleum. The offshore oil and gas ban means it is highly unlikely that an offshore player will come into the market. Whilst Kupe is a great oil &amp; gas asset, creating bidding tension could be the greatest challenge for GNE.</p>
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<div><strong>Andrew Harvey-Green</strong></div>
<div><a href="mailto:andrew.harvey-green@forsythbarr.co.nz" target="_blank" rel="noopener">andrew.harvey-green@<wbr>forsythbarr.co.nz</a></div>
<div>+64 4 495 8185</div>
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<div><strong>Scott Anderson</strong></div>
<div><a href="mailto:scott.anderson@forsythbarr.co.nz" target="_blank" rel="noopener">scott.anderson@forsythbarr.co.<wbr>nz</a></div>
<div>+64 4 914 2219</div>
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Genesis Energy Kupe&nbsp;Strategic Review a Positive

OUTPERFORM
Genesis Energy (GNE) has announced it is undertaking a strategic review of its 46% interest in the&nbsp;Kupe&nbsp;oil and gas field. The review will determine whether GNE retains or sells its stake in the field. The review outcome is expected to be announced in mid 2021, and we consider a sale is the most likely outcome of the review as the strategic need for GNE to own&nbsp;Kupe&nbsp;will diminish over time. We view the decision to undertake a strategic review as a positive.&nbsp;


Strategic review a positive move


GNE is effectively deciding whether to sell its&nbsp;Kupe&nbsp;stake or not.&nbsp;There are a number of reasons why&nbsp;selling&nbsp;Kupe&nbsp;now is attractive for GNE, including 1) firm gas prices as a result of the restricted&nbsp;Pohokura&nbsp;supply,&nbsp;2) exiting&nbsp;Kupe&nbsp;before it enters its decline phase, and 3) selling before further exploration and drilling, which would change&nbsp;the risk and return profile of the investment. In addition, selling&nbsp;Kupe&nbsp;will&nbsp;likely improve&nbsp;GNE's&nbsp;ESG perception.&nbsp;As part of the review, GNE will also be considering its capital structure, although somewhat surprisingly in our view this will not include a review of&nbsp;GNE's&nbsp;dividend policy.


Impact on earnings and dividend sustainability


GNE has indicated that the sale of Kupe will not impact its dividend. However, with Kupe producing between 25%–30% of GNE's annual EBITDAF, stripping out Kupe will have an impact on GNE's ability to maintain its dividend profile. We are forecasting FY21 free cash flow of 18.7cps, which would fall to 13.4cps without Kupe earnings, well below GNE's FY20 17.2cps dividend. In simple terms, the reduction in interest costs from selling Kupe is materially less than Kupe's cash flow contribution. However, GNE's dividend reinvestment plan and future earnings growth (due to the lower contracted gas prices) should ensure debt levels stay at manageable levels.


What could&nbsp;Kupe&nbsp;sell for and who are the potential buyers?


We estimate that Kupe could sell for between NZ$250m and NZ$400m. The net book value of Kupe on GNE's balance sheet is ~NZ$227m (22cps). Our Kupe DCF value is NZ$286m (27cps) — however, this does not include any exploration upside. The two recent Kupe transactions are GNE acquiring NZO's 15% stake and NZO acquiring Mitsui's 4% stake, both with an effective date of 1 Jan 2017. Those transactions imply a 46% Kupe stake of between NZ$402m to NZ$515m as of January 2017. Since then, gas prices have firmed, oil prices and interest rates have fallen, and we estimate GNE's Kupe cash flows from the past 3.5 years is ~NZ$300m. Estimating the possible sale price is challenging as GNE may alter the gas contract price for the 46% it is selling.
Potential buyers of Kupe appear limited. Todd Energy and OMV are the largest gas producers by a significant margin, potentially raising Commerce Commission issues. That only leaves three other gas producers; Beach Energy, NZ Oil &amp; Gas and Greymouth Petroleum. The offshore oil and gas ban means it is highly unlikely that an offshore player will come into the market. Whilst Kupe is a great oil &amp; gas asset, creating bidding tension could be the greatest challenge for GNE.



Andrew Harvey-Green
andrew.harvey-green@forsythbarr.co.nz
+64 4 495 8185





Scott Anderson
scott.anderson@forsythbarr.co.nz
+64 4 914 2219



Genesis Energy: Kupe Strategic Review a Positive