Interactive Investor

Stockwatch: why I’d hang on to this popular mid-cap oil company

20th May 2022 11:09

Edmond Jackson from interactive investor

Decent prospects remain at this business, despite blowing the chance of a bumper distribution to shareholders, argues companies analyst Edmond Jackson.

Last August I drew attention to then-named Cairn Energy CNE, a FTSE 250 oil & gas company, as a special situation at 172p. After a long-running dispute with the Indian government over retrospective taxation, an international arbitration panel had ordered India to settle for just over $1 billion dollars (£825 million) cash.  

At the end of 2020, Cairn’s balance sheet had £812 million net assets, equivalent to 163p a share, and oil & gas analysts had re-rated fair value targets to a 275p to 350p range, even before considering the prospect of a special dividend. 

Despite a volatile financial record and the stock having fallen from over 500p in September 2010 – and as low as 60p in the March 2020 Covid sell-off – a major cash injection also offered scope to refresh the business just when a restructuring was under way.  

A portfolio of Egyptian assets weighted towards gas had been acquired from Shell, with around 35,000 barrels of oil equivalent, production capability, plus exploration upside. Two North Sea assets had been sold for around £360 million equivalent and ENI, the operator of a deep-water well offshore Mexico where Cairn has a 15% interest, had declared a find. 

It was starting to look up for capital growth and dividends, and more recently the 11 May AGM statement cited stable production and 2022 exploration in Egypt, the UK and Mexico offering rapid commercialisation if successful. 

But eight months later and despite soaring oil & gas prices, the stock has made only modest progress to 227p last April, and is currently around 200p. There has been no special dividend as was repeatedly guided for in RNS announcements. 

Contorted tender offer replaced a special dividend 

Last September’s interim results highlighted that US$700 million (£550 million) would be returned to shareholders via a $500 million special dividend and buybacks up to $200 million; leaving around $300 million after costs, from India’s payout, to further enhance production. 

The buyback was initiated last November and a 6 January India Update cited $1.06 billion coming in. “The previously announced special dividend is expected to be paid in early 2022.” 

But the end of a 25 January update said that after consulting with shareholders, a tender offer would be substituted – where you had to stipulate a price within a range at which you were prepared to sell. Anyone tendering below the eventual strike price would get that price, but anyone above would fail to participate.  

Fair enough for professionals in the loop, but where did it leave individuals? You had to know how to engage a tender offer, and it’s unclear quite whether all nominee account holders gave clients enough time. Separately, I knew two private investors who died around this time, and any such estate holding the shares would have missed out. 

On 6 April the tender price was confirmed at 223p when 34.5% of the company’s issued equity was purchased by Morgan Stanley – then bought back by the company for cancellation.  

Shareholders who did not tender should – other things being equal - see an improvement in per share values, but I doubt this would match the return of value by way of special dividend. Holders have also had to sell an element of their stake to get a “return”. 

I’d like to know what individual shareholders were consulted by Morgan Stanley as part of their fee which has not been disclosed? 

I have seen few positive remarks by small shareholders as to how this has been handled; online discussions have mostly been scathing. 

If all shareholders have benefited from this exercise, the 6 April “completion of tender offer” RNS should have clarified what percentage of shareholders tendered, and the extent that it was successful. 

What are the ongoing prospects for Capricorn Energy? 

The re-naming happened last 13 December, retaining the CNE ticker, and the 8 March annual results showed the $1.06 billion tax refund from India re-balancing a $131 million operating loss (similar to 2020). 

This loss resulted from $51 million of unsuccessful operation costs (down from $79 million), $20 million impairment to intangible exploration assets and $58 million administrative expenses. 

There were also nearly $65 million net finance costs despite a modest $177 million debt and $314 million cash at end-December, even before the Indian inflow. This provides a strong platform for acquisitions. Success will depend on how astute management is at selecting targets. 

Oil and gas production generated $185 million net cash, and the Egyptian assets had exceeded production forecasts. 

Production was targeted to average 37k to 43k barrels of oil equivalent per day, just recently affirmed. Costs of $4.5 to $5.5 a barrel were expected to rise throughout this year, however. 

Admittedly, much needs to improve financially. It’s unclear quite why Capricorn Energy (LSE:CNE) has been left behind in the rush for oil & gas stocks like majors Shell (LSE:SHEL) and BP (LSE:BP.), benefiting the most as they capture high energy prices.   

The re-naming reflected the company’s new weighting towards the “Capricorn Egypt” acquisition but also underlined a break with Cairn’s past. 

Capricorn Energy - financial summary
Year end 31 Dec

  2015 2016 2017 2018 2019 2020 2021
Turnover ($ million) 0.0 0.0 33.3 410 533 0.4 64.4
Operating margin (%) 0.0 0.0 -729 -205 29.0 -32550 1,459
Operating profit ($m) -497 -148 -243 -842 155 -130 940
Net profit ($m) -515 -95.0 218 -1135 93.6 -394 895
Reported EPS (cents) -107 -19.6 43.6 -228 24.0 -31.9 171
Normalised EPS (cents) -61.6 -16.1 60.5 -108 6.7 -31.1 38.5
Return on capital (%) -22.7 -6.4 -8.1 -46.0 8.4 -8.7 45.6
Operating cash flow per share (cents) -3.1 -4.2 5.8 42.5 81.7 52.3 35.4
Capital expenditure per share (cents) 67.2 57.4 68.0 61.2 55.3 81.3 17.6
Free cash flow per share (cents) -70.3 -61.7 -62.2 -18.6 26.4 -29.0 17.8
Cash $m 603 335 86.5 73.2 152 575 401
Working capital ($m) 665 352 -39.2 69.5 190 519 1,436
Net debt ($m) -603 -335 113 194 131 -335 -220
Net assets ($m) 2,099 2,190 2,495 1390 1,456 1,126 1,799
Net assets per share (cents) 430 448 505 279 292 226 362

Source: historic company REFS and company accounts. Past performance is not a guide to future performance.

Mixed financial benefits from the new Egyptian asset base 

Management professes a low break-even point helped by a shorter investment cycle, although I have seen analyst criticism of how price-fixing in gas means Capricorn will not fully capture current high prices.  

That would explain the stock failing to rise as well as oil & gas companies which are less dominated by commodity price hedging. 

Some $200 million is targeted for capital expenditure this year, around half on Egyptian production and up to $35 million on exploration there, plus up to $40 million on UK exploration and the rest internationally, chiefly Mexico. 

Obviously, it will be a while before investors see what contribution to value the exploration can make, versus an inevitable element of continued writing-off. 

Scope for longer-term prospects to improve   

Around $76 million cash is expected during this second quarter from the sale of stakes in two North Sea fields where production has also been at the top end of guidance, with further bonus payments expected from this year to 2025. Circa $100 million could also come in 2023 or 2024 from a Senegal sale.  

All such implies a moving feast for profit and cash flows, but consensus looks for around $40 million net profit this year and next. 

The earnings per share (EPS) benefit from the share tender and buybacks reducing issued share capital is shown by a commensurately greater rise in sterling equivalent EPS forecasts, rising from 10.1p this year to 13.4p for 2023, despite net profit projected to ease 2% to £42.8 million equivalent in 2023. 

With the stock around 200p, the implied price/earnings (PE) based on reduced shares in issue is thus 12x on a 19-month forward basis. Possibly, the market reckons that is high enough until the new Capricorn shows what it is capable of.  

I confess my chief aim in drawing attention at 172p was the prospect of sizeable cash returns additional to stock held, which has not happened. Quite whether management bonuses benefit from enhanced EPS as a result of “returning” capital via buybacks remains to be seen.  

Capricorn does however look to be evolving a well-balanced portfolio of assets, hence merits ongoing attention. Hold.    

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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