Despite doubling production with a potentially game-changing acquisition in Egypt last month, shares in oil and gas player SOCO International (LSE:SIA) sit at 87.6p, significantly below highs of 129p hit in January. With the firm planning to advance its new foothold in the MENA region majorly over coming months and years while also making progress in Vietnam, we asked CEO Ed Story to explain why shares may be due a re-rate.
Strategic repositioning
This year has seen SOCO focus on expanding and diversifying its resource base beyond Vietnam to become a full-cycle, growth-orientated exploration and production business. To properly position itself for this strategic change, the firm sold off its non-core interests in the Congo and Angola earlier this year for $10m and $5m respectively. Following this, it took a significant step forward last month with the purchase of a company called Merlon, which owns the El Fayum concession in Egypt’s Western Desert.
The Western Desert is an established, producing hydrocarbon region with plenty of upside potential. Indeed, according to analyst Wood Mackenzie, it still holds 1 billion barrels of risked prospective resources despite its maturity. It is also cheap, with an estimated average well cost of just $3.8m over the last decade, with some costing as little as $1m.
SOCO has funded the purchase through a $136m cash payment and the transfer of a 19.8pc stake in its issued share capital. The firm will also arrange for the repayment of Merlon’s net debt, which came in at c.$22m at end-2017. As part of the deal, SOCO will also take on the Merlon team to help it develop the asset andits position in Egypt, with Merlon president and CEO Jason Stabellset to manage its business in the country.
Although the deal is still subject to shareholder approval and clearance from Egyptian regulatory authorities, SOCO expects it to complete in H1 2019. Story told us he invested in Merlon because it offers an ideal counterpart to SOCO’s existing position in Vietnam:
‘We were looking for an opportunity to diversify away from Vietnam as a single country investment and Egypt suited us very well due to my historic experience working there. We also have a very high regard for the business that Merlon has established in the country. Since the Arab Spring, there has been a turnaround in Egypt, thanks in part to the involvement of the IMF, which has been providing currency stability and additional funding to the country. It is now an established and mature hydrocarbon province, with a rapidly improving macro and investment climate.’
Immediately accretive
With Merlon producing 7,869bopd on average in 2017, the acquisition will be immediately cash generative for SOCO and will roughly double its existing production, which came in at 7,748boepd in H1 2018.
The concession also has plenty of upside potential, with net 2P reserves of 24MMbbls, net 2C resources of 37MMbbls and nearly 1,570km2 of exploration acreage. Of this, around 70pc is already covered by existing 3D seismic and features multiple, identified exploration prospects in proven petroleum systems with an un-risked OIIP resource potential of more than 500MMboe Story says he is particularly encouraged by the historically high levels of exploration success on the concession, which come in at more than 50pc:
‘This success rate is unusually high and a unique feature of the Western Desert. If we can continue this trend with the exploration acreage handed to us, then this area could have some serious room to grow beyond its already impressive 2P and 2C offering.’
Story also tells us that production costs come in at just $6/bbl, which SOCO expects to give the project a full-cycle 2P and 2C breakeven of $34/bbl- far below current oil prices. Thanks to the large amount of currently unused production capacity at the site, he adds that the firm will also save on development costs:
‘Merlon has unutilised production capacity up to 20,000bopd. So, with an operating cost of $6/bbl, there are no significant incremental development costs until you get past that level. We don’t expect to happen for some time.’
Development potential
On this point, SOCO believes its average production in Egypt will come in between 6,500-7,000bopd this year. However, it expectsto double this in 2019 and reach c.15,000bopd by 2023. It plans to achieve this by recovering 2P reserves and 2C resources through infill drilling, workovers and waterflood expansion.
What’s more, the company plans to use existing cash flows to fund this development activity, allowing it to maintain a robust balance sheet and continue distributing excess free cash flow to shareholders as dividends. Story says the business is now working on the necessary approvals to get started on this development work as soon as possible, post-acquisition:
‘With the exploration potential also included, we havebeen toldthat El Fayum has a resourceequivalent to major Texas shale play Eagle Ford. We already knew that because a larger company had approached Merlon with a proposal, but they chose us. We would liketo start working on this resource as soon as possible. We are in the process of getting government approvals and will then begin adding local drilling rigs to pick up the pace ofwaterflood activity, exploration, and additional development wells.’
Looking forward, SOCO also hopes to use El Fayum as a strategic platform for future growth in Egypt and the wider MENA region. Story tells us he plans to use his own experience and relationships in Egypt – as well as those of Merlon – to get the ball rolling here:
‘We have in place a very powerfuloperating organisation that could be expanded organically within Egypt and other operations in the whole MENA region. We also think there are a lot of consolidation opportunities within Egypt. We will be delivering a lot here over the coming months and years.’
Vietnam programme
Alongside Egypt, SOCO has an established production base in Vietnam. Here, the firm owns a 28.5pc stake in the TGT field on Block 16-1, which produced an average of 6,177 boepd net to the business in the first half of 2018, down from 7,056boepd in H1 2017. It also owns a 25pc position in the CNV field on Block 9-2, which delivered a net output of 1,571boepd net in H1 2018, down from 1,550boepd year-on-year.
SOCO had been planning to carry out a three-to four-welldrilling programme this year, but this was delayed significantly byweather conditions and a requirement to re-drill a sidetrack on a well at CNV. The delayresulted in the company’s production guidance for 2018 being revised down from 8,000-9,000boepd to 7,000-7,400boepd in July. Story tells us the campaign is now likely to slide over into next year but adds that he remains positive about the impact it will have on production in Vietnam:
‘We got a very late start this year in the drilling campaign. The well at CNV is very interesting and should reach total depth imminently. We will then drill one well on the other field before drilling two-to-three more wells next year.’
Re-rate opportunity?
SOCO’s share price has broadly been in decline since May, falling from highs of 122p to its current 87.6p, which gives the business a market cap of £290.5m. There could be an argument that this looks under-valued.
Firstly, as it stands, it is difficult to get an accurate sense of SOCO’s current cash balance and net current assets. According to the company’s interims, cash sat at $128.8m as at 30 June, andsince then it had enjoyed three full months of production revenues and has taken in $5m from the sale of its Angolan interests. However, over this period, it has also spent $137m on the Merlon acquisition and spent c.$5.25m on administrative expenses (based on a $10.5m spend in H1 2018).
Until we get an exact figure, it is certainly encouraging to knowthe firm plans to continue paying a dividend following the Merlon acquisition – this doesn’t seem to suggest it is strappedfor cash.
Regardless, if we convert £290.5m into $380.2m, SOCO’s market cap equates to roughly two years of revenues based on H1 2018 turnover of $93.2m. Given that the Merlon acquisition roughly doubled SOCO’s production, it seems an educated guess that revenueswill also double, which, in theory, could mean its current market cap is now equal to just one year of turnover.
If we couple this with strengthening oil prices and SOCO’s plans to double Egyptian production next year, it does seem surprising that shares have not risen since the acquisition. In fact, they fell by 4.6pc on the day of the news.
Story tells us he believes the firm’s shares have been on a downward trend this year because investors had been waiting to see how it planned to deliver on its growth strategy. Now the acquisition has been madeheexpects a re-rate to be on the cards as SOCO continues to providenewsflow:
‘One side of the potential buy side has been waiting to see what we were going to do for a new opportunity, and I think investors are still digesting this. Another part of the market was waiting to see what was happening in Vietnam and we still need to demonstrate what is happening there. We are far from being finished with additional building blocks into this company; therewill be more to follow in Egypt, Vietnam and other areas. We will look for them all to be accretive, strengthen growth and transform our size.’
All in the delivery
The acquisition of Merlon last month marked a significant turning point for SOCO, doubling its production and opening it up to a whole new continent of potential future opportunities. If the business can deliver on its increased production and exploration plans – both in Egypt and Vietnam – then the future could certainlylook very bright. The fact that the firm is already churning out nearly $100m of turnover every six months and paying a healthy dividend is all the more comforting. With SOCO remaining depresseddespite the significant progress it has made and the potential upside it now offers, shares could well be worth a look.