Risky investing in Enquest PLC, despite the 67% share price decline

Enquest PLC was born from the demerger of Petrofac and Lundin Petroleum in 2010. Most of its operations are in the North Sea (UK). It also has an interest in Malaysia.

So, what happened since then,

It raised £57m at £1.18/share, valuing it close to £500m. Today, the market value is £450m, not a big loss you would imagine.

By acquiring companies via issuing stock and open offer, the total share count rose from 442m to over 1,159m.

That means, if you bought into the IPO at £1.18/share, you are sitting on a loss of 67%!

At 39 pence per share (25/04/2017)

 

In my previous article, I analysed Tullow Oil and found some similarities with Enquest. One is the fall in oil price which led to huge losses leading and the other is ramping up of capex spending.

 

(P.S. It’s probably the case for most oil companies because of long-term contracts commitments.)

To understand Enquest PLC, you need to cover the following information. These are: –

  1. Where is the position of Enquest Market Value and Enterprise Value at any given period?
  2. Understanding how much debt is affecting Enquest’s operations.
  3. The importance of Asset Turnover and the role it plays for measuring heavy capex companies.
  4. What is Enquest record of producing extra sales from the new capital investment it makes each year?
  5. The role capital commitments play in oil producers and why you shouldn’t look at the cash balance.
  6. Is there free cash flow generation? 
  7. Enquest’s bond price; – will bondholders screw shareholders?
  8. Change to its 2P Reserves, what has all this spending did for Enquest?
  9. Assessing Enquest 2017 guidance.
  10. Further thoughts.

 

 

 

MAIN CONTENT

 

3 Big Transformational Shifts at Enquest PLC – Investors need to know

 

Enterprise Value and Market Value Swap

Don’t be fooled by the subtitle because I am not suggesting this is a new form of derivative.

I’m trying to say that debt has overtaken equity as the main source of financing.

ENQUEST PLC Enterprise Value

You noticed the market value peaked at £1bn and then fell to £250m, before recovering to £450m. However, the enterprise value shot from £420m to £1.7bn like a straight-line.

It’s almost like Enquest borrowed more and more to replace its declining market valuation.  

This makes Enquest PLC a risky investment for shareholders because debts incur interest costs. That increase in financial leverage means if the creditors are struggling (i.e. think financial crisis 2008/09), then they will demand their money back, which likely be the whole company.

Unless debts get repaid, the company’s share price will see limited gains.

More Debt than Equity

Sticking to the debt theme.

 Enquest PLC Debt Pattern

Here is the evidence why the Enquest PLC will serve the bankers because of the “debt-to-capital” composition is over 70%.

That means shareholders controls less than 30% of the business! (i.e. less say in the company)

Enquest’s shares outstanding isn’t due to raising more equity but acquiring two oil and gas companies. Details are: –

  1. The acquisition of Stratic for $54m, which was settled issuing 24m new shares;
  2. The acquisition of PEDL for $513m and settled with further 345.6m new Enquest shares.

 

However, Enquest did raise money from shareholders for $105m last year.

ENQUEST PLC FINANCING RAISED

Since floating on the market, Enquest also raised a total of £1.3bn in total borrowings.

 

Don’t ignore Asset Turnover

We know low oil prices would slow its asset turnover, however. Given the levels of writedowns totalling £769m ($1bn), you would think that Enquest assets are priced very low.

But, the asset turnover ratio tells us otherwise.

Enquest PLC - poor returns from capital spending

The blue graph showed assets valuation at Enquest dipping from the peak of 0.6 times to 0.2 times. A 67% declined.

One reason for this is spending more money to replace the value lost on their assets via impairments, by adding more additional assets via capex.

That just open up for more asset writedowns, if the oil price took a turn for the worse. 

More worryingly, the orange graph is telling investors for every “British Pound” invested, Enquest is getting six British Pence in return.

That is the effect of lower oil prices on oil producers.

 

Is Enquest pouring money down the drain or do they have another agenda?

Earlier, I mentioned Enquest made 6 pence for every British Pound invested.

Normally, with low oil prices, Enquest would suspend capital investment till oil prices get back to levels that make business sense.

It’s not that simple, because of Capital Commitments. Oil producers are contracted to carry out these commitments two or three years ahead of time.

Enquest's capital commitments

Now, capital commitments are coming down. Next year, Enquest future commitment will fall further.

 

These future commitments aren’t pleasing to investors, as free cash generation is negative to the tune of £1bn in six years.

Enquest Plc free cash flow

If the cutbacks in capital commitments are real, then negative free cash flow gets smaller, even if prices stay around $50 bucks.

 

Should you be worried about Enquest’s bond price?

We know Enquest has lots of debt, but we don’t know the kind of debts it possesses in their books.

Below are different types of debts: –

ENQUEST DEBTS

The company is paying a high interest to keep itself alive, with the high-yield bonds paying out a 7% coupon and the retail bonds at 5.5%.

The credit facilities are between 2.5% and 4.25% over LIBOR.

People make the mistake of taking the interest costs from the P&L Statement. For an accurate assessment, go to the finance costs/income notes and you will find the two main interest costs.

In 2016, Enquest has to pay $50.8m on loans and $59.7m on bonds interests. Together with its $110.5m or £78m interest per annum, it is equivalent to 12% of revenue.

Now to assess Enquest’s bond prices vs. its share price.

Enquest bond prices

Again, Enquest’s bonds track the oil price.

 

The Benefits of Enquest Capital Spending

Although, the timing of its capital spending was unfortunate. But, the amount of capex spent is big and shareholders would like to know if it was all worth it? 

The following points are covered: –

  1. How long will net 2P reserves last?
  2. The operating and realised oil price per barrel.
  3. My deliberation on operating costs per barrel.
  4. Capital spending on building its net oil reserves.

 

 

How long will net 2P oil reserves last?

Let’s start with 2P net reserves. Since 2009, Enquest has sold a total of 76m barrels to date.

The current level of production is 14m barrels.

Enquest number of years in reserves

It would last 15 years on current production levels, but two years ago, this was 22 years.

How long oil reserves last, got nothing to do with declining oil reserves, but rather the increase in oil production.

 

The operating and realised oil price per barrel

Below is a chart showing Enquest PLC operational costs.

Enquest operating cost and sales price per barrel

You would be forgiven to think Enquest is a special oil company!  

It didn’t turn out that way, as the shares took a battering. That should have you wondering if the company accounted for all of their costs.

 

My deliberation on operating costs per barrel

 

The way investors should work out operating costs is: –

Revenue minus Operating profit, but excludes net exceptional costs. My research is shown in the graph below: –

 ENQUEST PLC - My Assessment on its opex per barrel

Operating profits turn to losses as realised sales per barrel fell below operating costs per barrel.

The difference between my opex/barrel and Enquest’s opex/barrel is: –

Opex per barrel comparison

My analysis relies on Enquest’s financial statements, which can get distorted. For example, capitalising expenses in the “Non-Current Asset” items.

 

Capital spending on building its net oil reserves 

Capex per barrel is almost impossible to work out and not reliable because of fluctuation in spending year-on-year. Also, we have to factor in empty or uneconomical oil wells, which expenses abandonment costs of the wells.

So, the best way to go about this exercise is to get the average capex per barrel over a period. In the case of Enquest, it’s over six years.

Here is the step-by-step guide to measuring the cost of finding, acquiring and getting oil out of the ground: –

Step 1

Gather the raw numbers.

Since 2009, total capex = £3,259.7m. The disposals came to £145.44m. And total depreciation comes to £1,139.3m.

 

Step 2

Work the change in 2P oil reserves.

As mentioned earlier, Enquest sold 76m barrels to date, but 2P oil reserves saw an increase from 80.5m to 215m barrels, the resultant change is 134.5m.

 

Step 3

Work out the average capex per barrel.

You can work this out in two ways: –

  1. Include the replacement barrels, or
  2. Don’t.

 

(Include replacement of barrels): – Capex (£3,259.7m) minus Disposal (£145.44m) = £3,114.26m.

The total increase in reserves, adding in the total oil production sold to date is 134.5m + 76m = 210.5m barrels.

So, £3,114.26m divided by 210.5m barrels = £14.79/barrel ($19 per barrel).

 

In the interest of working out total costs per barrel. You can’t use the replacement numbers because my “Opex per barrel” includes depreciation charges!  

So, (without replacement barrels): –  Capex (£3,259.7m) minus Disposal (£145.44m) and minus depreciation (£1,139.3m) = £1,974.96m.

Using total reserves increase of 134.5m, then £1,974.96m divided by 134.5m = £14.68 per barrel ($19 per barrel).

No matter, similar results have prevailed!

 

Add the average capex per barrel of $19 to Opex per barrel for each year, you get this.

ENQUEST PLC - My Assessment on total costs per barrel

(N.B.: Capex per barrel is a rough estimate. When capex spending gets smaller, then capex per barrel is low.)

 

ENQUEST PLC 2017

Management gave 2017’s guidance of 45,000 BOPD – 51,000 BOPD, dependent on Kraken producing its first oil.

How much could operating profit be made?

To assess this, I can’t use Enquest’s opex of $20 per barrel because it’s a little bit misleading (Read section “The Benefits of Enquest Capital Spending”).

I will stick with last year opex of $37 per barrel.

Take the average production of 48,000 Bopd. Capex is $400m. Let’s us envisage three scenarios: Worst-Case, Base-Case and Best-Case.

 

Best-Case scenario ($80 per barrel): – 48,000 Bopd multiply 360 = 17.28m barrels sold. Revenue is $1,382m.

Operating Expenses; – 17.28m multiply $37 = $639m. So, operating profits = $743m (£580m)

Assume net finance costs = $100m; 

Profit before tax = $643m (£502m).

(P.S. Enquest PLC could revalue its assets higher to reflect the high oil price, so accounting profits likely be greater.)

 

Base-Case Scenario ($55 per barrel): –  17.28m multiply by $55 = $950.4m in revenue.

Operating Expenses; – 17.28m multiply $37 = $639m. So, operating profits = $311.4m (£243.3m)

Assume net finance costs = $100m; 

Profit before tax = $211.4m (£165m).

 

Worse-Case Scenario ($45 per barrel): – 17.28m multiply by $45 = $777.6m in revenue.

Operating Expenses; – 17.28m multiply $37 = $639m. So, operating profits = $138.6m (£108.3m)

Assume net finance costs = $100m; 

Profit before tax = $38.6m (£30.15m).

And in this scenario, you know Enquest would write down more of its assets valuation to reflect reality. That could result in a net loss.  

 

Further Thoughts

At this moment, Enquest PLC is a risky investment because of elevated debt levels. But, investors are hoping for the new Kraken oil field to come online. That will boost oil production to 48,500 BOPD (average of 45k-52k).

My main concern is Enquest’s management and their lack of commitment to debt reduction. I know credit facilities are some time away from maturing. But time flies if you are hoping for the higher oil price to appear.

Also, given the length of this bull market, you would do well to invest in safe stocks, especially ones with low debts.

Enquest 2P reserves have 15 years of production. Increasing oil production in 2017 by 30% from last year would cut the years of oil reserves.

I wouldn’t invest in Enquest because oil price (even at $65) is too low. Even if it makes a profit, it doesn’t matter.

The one metric I watch for heavy capex companies is positive free cash flow generation. Without it, Enquest can’t pay off their borrowings, so how would they pay any future dividend to shareholders?

Enquest is for the short-term traders and bondholders, not the medium and long-term shareholders.

As a long-term shareholder, I won’t recommend owning this stock at current levels. makes an interesting play because of its volatile price movements.

I would like to give my share price projection by copying the three-case scenario: –

  1. (Best-case scenario, when oil at $80); – Enquest’s shares should roar higher, as the prospect of debt repayment is likely. That and higher profits would drive the shares to 70 pence.
  2. (Base case scenario, when oil at $55); – Enquest’s shares will struggle, and trade around 30 pence to 50 pence.
  3. (Worst-case scenario, when oil at $45); – Enquest’s shares would decline to 25 pence or lower. With the extra debt on their backs, it wouldn’t surprise me if bondholders took over the business.

 

Is there hope for Enquest PLC to recover back to its glory days? Please leave your comments below. 

If you like this piece, then hit that like button. Please share if think its informative and subscribe for new posts. 

Disclosure

The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.

Finally, the writer does not own the company’s stock, unless stated otherwise.

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