Rex International - UOB Kay Hian 2019-12-12: Near First Oil Production, Backed By Huge Cash War Chest & Assets

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REX INTERNATIONAL HOLDING LTD (SGX:5WH)

Rex International - Near First Oil Production, Backed By Huge Cash War Chest & Assets

• REX INTERNATIONAL (SGX:5WH) has proven its ability to create substantial value from its recent divestment of two Norwegian assets to Lundin Norway for US$45m and its remaining assets could be worth more vs its book value. Rex International targets to achieve first oil in Oman by 1Q20 and we expect a strong cash flow if production drilling is successful.
• Also, Rex International has a strong net cash balance of S$89.5m, forming 41.5% of its market cap.
• We initiate with a BUY and SOTP-based target price of S$0.218, implying 1.1x 2020F P/B.

Investment Highlights

Deeply undervalued given first oil prospects and strong balance sheet.

• Boosted by the recent Rolvsnes transaction, Rex International boasts a strong net cash balance of S$89.5m. Rex International still has many valuable assets on their balance sheet as well as tax incentives from the Norwegian government. Rex International targets to achieve first oil in Oman by 1Q20 and we expect a strong cash inflow of S$51.6m in 2020 if it is successful. In addition, the Norwegian government provides a 78% cash-back for exploration expenditure, deleveraging Rex International’s balance sheet.
• Rex International also owns three valuable concessions in Norway of which oil discovery in two of the exploratory assets would unlock huge value for Rex International. The last concession, the Shrek Prospect, was recently discovered to have oil. We believe the Shrek prospect could be worth a lot more than its current estimated book value of US$16.6m.

Strong expertise and track record in divesting of Norwegian assets.

• After divesting of the licences for the Rolvsnes discovery, Rex International still owns three Norwegian assets:
  1. 30% stake in PL818 and PL818B in the North Sea,
  2. 20% stake in PL841 in the Norwegian Sea, and
  3. 30% stake in PL838 and PL838B (Shrek prospect) in the Norwegian Sea.
• In Oct 19, the Shrek prospect was discovered to have oil.
• In the event that oil is found in the Norwegian assets, coupled with confirmation from the Rex Virtual Drilling (RVD) technology, Rex International could either divest of its licences or participate in production drilling. Divesting of the licences before production drilling would provide Rex International with a lump sum of cash, removing the need for production drilling capex. Additionally, Rex International could sell half of its licences while allowing the other half to move into production drilling.
• Rex International has a track record in monetising its oilfield assets as seen by the agreement with Lundin Norway to divest of its interests in two assets for US$45m, with the company realising a gain of around US$30.0m. The Rolvsnes discovery was estimated to contain roughly 14m-78m bbl of oil, with Rex International owning a 30% interest.
• Based on our assumptions, we estimate the fair value of the Shrek prospect at US$42.8m, instead of the prospect’s current estimated book value of around US$16.6m. As the Shrek prospect is located near the Skarv Floating Production Storage and Offloading (FPSO) facility, we reckon that Rex International is able to sell the asset at a premium as the close proximity to the FPSO facility would mean lower production drilling capex needed if an operator was to commence production drilling.
• Due to its expertise and track record in monetising its discovery assets, Rex International may divest of its licence for the Shrek prospect in 2020 to a potential operator, realising a net gain of around US$26.2m in 2020 via other income.

First oil production from Block 50 Oman to produce strong cash flow in 2020.

• Assuming no delays in setting up the rig and drilling equipment, management expects production drilling to commence in 1Q20. Also, revenue contribution from Block 50 Oman is expected to start in 2020. We estimate Block 50 Oman to contribute revenue of US$143.4m in 2020 and generate an operating profit of S$51.6m.
• We have based our assumptions on an average production of 5,000 bpd starting from 2020 till 2024, a 35% oil revenue split to the Omani Government, an operating profit margin of 36% and an oil price of US$65.00/bbl. We have included different scenarios in the financials section of this report.
• As of 3Q19, exploration and evaluation assets remained at US$93.9m, of which at least US$73.1m consisted of the assets in Oman. Furthermore, the Oman Oil Company is understood to have an option to farm-in up to 25% of Block 50 Oman. If exercised, the option would boost Rex International’s current cash balances further and provide Rex International with a bigger cash war chest for more exploration projects in Oman, something management plans to do in the future.

Substantial cash from divestments and annual tax incentives.

• Norway is very supportive of oil exploration as the government provides 78% cash-back for all exploration expenditure annually, regardless of whether oil is found. The cash refund would be paid out in November/December in the following year. According to Rex International’s 2018 annual report, Rex International is due to receive a cash tax rebate of US$29.1m in Nov 19; this has been included in its trade and other receivables account and further increases Rex International’s net cash position for 4Q19. We have learnt from management that cash gained from the tax rebates would be used to repay borrowings on its balance sheet in the same financial year.
• For 100% of exploration expenditure costs, Rex International takes a loan of 78% from banks and utilises cash for the remaining 22%. The Norwegian government then provides cash-back for the 78% borrowed in November in the following year. Therefore, existing debt on the balance sheet would be paid off in the next financial year. Repayments of bank loans on Rex International’s cash flow statement are almost identical to the amount of tax rebates received from the Norwegian government in the previous year. By continuing its exploration activities in Norway, Rex International is able to use the tax rebates to de-lever its balance sheet or cle capital for more exploration activities, ensuring a fundamentally strong balance sheet.

Valuation

Trading at 2020F P/B of 0.8x, with net cash balance forming 41.5% of market cap. We initiate BUY with SOTP-based target price of S$0.218, implying 1.1x 2020F P/B.

• Rex International is trading at 0.8x 2020F P/B, below its long-term average of 1.0x P/B and relatively low vs the industry average of 1.3x 2020F P/B. As of 3Q19, NAV/share stood at US$0.116 (S$0.156). See Rex International Share Price.
• Rex International still owns many undervalued assets in its balance sheet that could unlock huge value for the company. We believe that revenue from the production of oil in Block 50 Oman coupled with the sale of the Norwegian discovery assets would help boost its NAV/share and narrow the P/B gap between Rex International and its peers. We initiate coverage with a BUY rating and a SOTP-target price of S$0.218, implying 30.3% upside from the current closing price.

Financial Forecasts

Surge in revenue and profitability from start of oil production.

• We forecast strong revenue numbers for Rex International from 2020 onwards, largely due to the expected commencement of production drilling in Oman. Revenue forecasts for Block 50 Oman average US$71.7m/year. This is based on the assumptions of an average production rate of 5,000 bpd starting 2020, an operating profit margin of 36%, an oil price of US$65.00/bbl and a 35% revenue split to the Omani government.
• As the oil found from the discovery well in Oman was good-quality light oil, we have assumed that it would sell at a price which is at least on a par with the current Omani crude oil price of US$$65.0/bbl. Our revenue and PATMI estimates for 2019-21 are at US$0.5m, US$144.0m and US$86.8m, with PATMI at US$20.3m, US$52.5m and US$12.5m respectively.

More about Rex International

• Rex International Share Price History;
• Rex International Target Price;
• Rex International Analyst Reports;
• Rex International Dividend History;
• Rex International Announcements;
• Rex International Latest News.

Overview Of Norwegian Assets

Rex continues to have interests in licences in Norway

• Rex International continues to have interests in licences in Norway that are close to existing producing fields and pipeline infrastructure, allowing a fast-track path to potential commercialisation and return on investment when more discoveries are made in its assets.
• Lime Petroleum AS (LPA), as a prequalified company, benefits from the Norwegian tax system with 78% cash-back on all exploration expenditures. This system has been a huge success since its introduction in 2005, allowing diverse companies to drill a sufficient number of wells, resulting in a string of significant discoveries in all provinces of the Norwegian Continental Shelf.

Rex has adopted a value creation strategy

• Rex International has adopted a value creation strategy, particularly in Norway,built on its unique technology-led, de-risked exploration approach. The portfolio will be re-built through awards in licensing rounds and farm-in transactions with the company targeting to participate in one exploration well activity per year, giving the potential for a step change in the form of a value increase.
• Three strategies have been identified going forward:
  • Pro-active evaluation of farm-in opportunities,
  • extensive applications in the upcoming annual licensing round for cost-effective portfolio growth, and
  • continued use of RVD to de-risk geological evaluations.

Norway continues to produce a significant amount of oil and gas.

• According to the Norwegian Petroleum Directorate (NPD), Norway produced a total of 86.2m Sm³ oil (1.49m bpd) in 2018, compared with 92.2m Sm³ (1.59m bpd) in 2017, down 6.3% y-o-y. The NPD forecasts production to increase from 2020 to 2023, following a slight decline in 2018/19. Total production of oil and gas in 2022/23 is estimated to be close to that in the record-breaking year of 2004.
• In the 50 years since Norwegian petroleum activities began, about 47% of the estimated total recoverable resources have been produced and sold. Thus, there is a large volume of remaining resources, and it is expected that the level of activity on the Norwegian Continental Shelf will remain high over the next 50 years as well.
• All of Norway's oil reserves are located offshore on the Norwegian Continental Shelf which is divided into three sections: the North Sea, the Norwegian Sea and the Barents Sea. The bulk of Norway's oil production occurs in the North Sea. New exploration and production activity is taking place further north in the Norwegian Sea and Barents Sea.

More exploration wells were spudded in the North Sea.

• According to the NPD, 53 exploration wells were spudded in 2018, compared with 36 in 2017. Most of the wells drilled in 2018 were drilled in the North Sea. Eleven discoveries were made, with a preliminary resource estimate of 82m standard cubic metres of recoverable oil equivalents (o.e.). This is higher than that in each of the three previous years.
• Exploration costs are expected to increase by 10% from 2018 to 2019, after which a moderate reduction is expected over the next few years. In the Awards in Predefined Areas (APA) 2017, which were awarded in early-18, 75 new licences were awarded to 34 companies. Of these, 45 are located in the North Sea, 22 in the Norwegian Sea and 8 in the Barents Sea.

Overview Of Omani Assets

Oman is the largest oil and natural gas producer in the Middle East outside the Organization of the Petroleum Exporting Countries (OPEC).

• According to Thomson Reuters, Oman had an estimated 4.7b bbl of proved oil reserves as of 2018. The National Centre for Statistics and Information (NCSI) reported that the Sultanate’s crude oil production, including condensates, stood 0.8% higher y-o-y at 326.3m barrels in 11M18. This is against an output of 323.7m bbl for the corresponding period of 2017. Of the total production, crude oil production was down 1.7% at 290.2m barrels.
• Oman recorded a daily average crude oil production of 977,100 barrels during 11M18. The average price of Oman Crude surged by 35% to US$68.70/bbl in 11M18, from US$50.90/bbl in 11M17. One of Oman’s critical infrastructure projects is the development of a port and industrial area (including a refinery and petrochemical complex) in the strategically-located town of Duqm, on the Arabian Sea. A US$400m crude oil storage terminal is also being built in Duqm, the first phase of which will have a storage capacity of 10m bbl of crude oil.

Block 50 Oman concession.

• The approximately 17,000 sq km offshore concession is located in Gulf of Masirah, offshore east Oman and the town of Duqm. Masirah Oil (MOL) holds 100% of the Block 50 Oman concession. Rex International holds an effective interest of 92.65% in MOL through its indirect wholly-owned subsidiary Rex Oman. MOL is also 2.35% held by Petroci, the national oil company of the Ivory Coast (also known as Côte D`Ivoire) and 5.00% held by Schroder & Co Banque S.A. Block 50 Oman is one of the first concessions secured by the founders of Rex International before the company’s IPO. On 4 Feb 14, an oil discovery was announced at Block 50 Oman.
• The second exploration well that was drilled in the concession had successfully reached the well depth target of more than 3,000 metres into the Cambrian formation. Hydrocarbons were discovered in several formations with good oil samples extracted. The oil discovery is significant as it is the first offshore discovery east of Oman, after 30 years of exploration activity in the area, and won the “Offshore Discovery of the Year” award.
• During a 48-hour test, hydrocarbons were flowed to the surface and the well achieved a restricted flow rate of 3,500 bpd of high-quality light oil without water production from a sandstone reservoir of excellent quality. In 2017, the Karamah#1 well which was drilled identified a 5-metre oil bearing interval on the wireline logs in a carbonate reservoir, further confirming the presence of a working petroleum system in the block.

Key milestones achieved in 2018.

• Four key milestones achieved include:
  1. carried out feasibility study on discovery well Yumna, based on reprocessed seismic data which was re-analysed with an updated version of RVD (RVD version4) and substantial conventional interpretation;
  2. finalised updated mapping of the block with a view to determining possible drilling on prospects that could be taken forward for production in parallel or sequentially with the Yumna discovery;
  3. announced the group’s consideration to maintain a high equity stake in Block 50, following the encouraging results of the feasibility and concept studies on the Yumna discovery well; and
  4. appointed an independent investment bank as financial adviser to review non-dilutive financing options and to conduct fixed income securities meetings to fund the development activities at the Yumna discovery.

Plans to unlock value from huge recoverable cost pool.

• A recoverable cost pool of more than US$100m has been accrued from exploration activities on the Block 50 licence. This cost pool can be deducted against revenue in the production phase, significantly increasing the economic attractiveness of the Yumna discovery. The extensive technical works carried out on the licence have de-risked exploration potential.
• The plan is to use free cash flow from the production at Yumna to fund a new exploration drilling campaign focused on the prospects adjacent and similar to the Yumna discovery. New discoveries could be developed in parallel or sequentially with Yumna, utilising the same equipment. Hence, production could be increased in volume and duration while reaping economies of scale.

Yumna discovery is only a small part of Block 50 Oman.

• Obtained from the prospectus of another E&P company Hibiscus Petroleum, AkerGeo did a Qualified Person’s Report on the prospective resources in Block 50 Oman. As seen from the table below, Yumna’s (GA South) P50 is 3.18m barrels, only 0.6% of the total P50 in Block 50 Oman.
• Although P50 implies the quantity stated has at least 50% probability of being exceeded, this still shows the vast amount of oil reservoir in Block 50 Oman that Rex International has yet to drill and discover.

• In the recent SGX Market Updates, Rex International is highlighted as one of the SGX Stocks with Consistent Momentum in Recent Years.

• See attached 16-page PDF report for complete analysis on Rex International.

Llelleythan Tan UOB Kay Hian Research | https://research.uobkayhian.com/ 2019-12-12

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