Focus On Europe: BW Offshore Buys An Oilfield From Petrobras

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In this edition of Focus on Europe, we will revisit an old Top Idea here in Seeking Alpha. In May 2018, a case was made for BW Offshore (OTCPK:BGSWF), the provider of FPSO vessels for offshore oil production. The price has been very volatile, so let’s catch up on what’s happening with the company.

Did you miss the previous edition of Focus on Europe wherein the (alleged) Scandinavian money laundering issues were discussed? Re-read the Swedbank (OTCPK:SWDBF) article here.

A brief recap of BW Offshore

About a year ago, a Top Idea article was published on BW Offshore, which you can re-read here to get a more detailed background of the company.

Source: Yahoo Finance

BW Offshore’s vessels are now finally running at full capacity; the BW Adolo has been hooked up to the Dussafu oil field and the massive BW Catcher is running above nameplate capacity which allowed BWO to renegotiate the contract for the FPSO.

In the fourth quarter, BW Offshore generated a revenue of $255M (+$33M compared to Q3 2018), and an EBITDA of just short of $149M (+$22.5M vs. Q4, indicating the EBITDA margin on the incremental revenue was approximately 68%. This includes the revenue and (gross) profit contribution from the Dussafu oilfield as the 91.67% stake of BW Energy (in which BW Offshore has a 2/3 interest) was fully consolidated in BW Offshore’s financial results.

Source: financial results

The excellent performance in Q4 lifted the full-year EBITDA to $489M (which means the final quarter alone represented 30% of the full-year EBITDA. The $489M is a bit below my expectations, but this could be due to the timing of the oil lifts. After all, BW Offshore’s joint venture incurred the expenses of producing almost 1 million barrels of oil, but only sold 504,000 barrels (the company makes a big deal out of it by referring to the IFRS 15 rules, but I consider this to be perfectly normal). So on a normalized basis, the EBITDA would have met the $500M hurdle even on a de-consolidated basis at Dussafu, so I’m not unhappy. A third lifting of 650,000 barrels (almost 400,000 barrels net to BW Offshore) was sold in January at $59/barrel for an operating margin of approximately $35/barrel. Ka-ching, ka-ching!

For the entire financial year, the total revenue came in at $870M with, as mentioned before, an EBITDA of $489M. This doesn’t mean BW Offshore has generated a big net profit as well, as the depreciation charges obviously increase as well ($339M, up $100M compared to FY 2017) while the interest expenses also doubled to almost $80M. The pre-tax income was approximately $77M, resulting in a net income of $33.5M attributable to the shareholders of BW Offshore, which is the equivalent of $0.18 (or 1.55 NOK).

About the tax bill (and tax pressure of almost $58M): The majority of this was actually due to starting up the oil production in Gabon ($10.5M) as well as an additional $4M tax charge due after a tax audit in Gabon. The $4M additional tax should not re-occur in the future, and the relatively high tax bill in Gabon should decrease as well as BW Offshore will find a better balance between production and sales which will help to mitigate sudden swings in the taxes.

Source: BW Offshore financial results

On the cash flow front, BW Offshore was pretty much breaking even. It reported an operating cash flow of $436M, and after isolating changes in the working capital position and deducting the interest expenses (which were booked as a financial expense rather than an operating expense), the adjusted operating cash flow was approximately $386M.

Plenty of money to fund the $357M in capex, resulting in a net free cash flow of $29M. Low? Definitely. But keep in mind 2018 was the year to get the BW Adolo and the Dussafu oil project ready for production. According to the presentation, $187M was spent on developing Dussafu, with an additional $170M spent on other capex. However, this still includes the BW Adolo and the final investments in the BW Catcher, so the sustaining capex is very likely less than half that amount, as BW Offshore had been guiding for a $125M capex for the BW Adolo.

Source: BW Offshore presentation

The underlying sustaining capex is very likely just $50-75M. Which makes sense as the FPSO’s are designed to be in production for 10-20 years without any interruption for maintenance. If that’s the case, the underlying sustaining free cash flow will be around $300M per year.

I’m not sure when we will see those ‘pure’ numbers in the cash flow statement as the 2019 results will very likely include the development capex of Tortue 2. But one thing is for sure; excluding any new FPSO development work, I do expect the reported free cash flow in FY 2019 to be at least $200M while the underlying sustaining FCF should be north of $300M thanks to the contribution from the Dussafu oil production.

Why was the market disappointed?

I think there are two main reasons why the market ‘rewarded’ BW Offshore with an 8% lower price. First of all, the price had already increased by approximately 50% since the end of December, and it looks like some anticipation on ‘new elements’ was already built in. That’s perfectly understandable as I was also hoping for BW Offshore to announce at least one new FPSO contract, but unfortunately, BWO just mentioned the discussions with Petrobras (PBR) with regards to the FPSO Cidade de Sao Mateus are ‘ongoing’.

Additionally, BW Offshore explicitly mentioned it’s not allowed to pay a dividend or buy back stock until its final bond matures in 2022. This clause was added during the refinancing efforts in 2016 and was meant to protect the bondholders, but I think this is something that could (and should) be renegotiated.

On the one hand, I don’t mind it if the cash remains inside the company as it will put BW Offshore in an excellent position to just pay off maturing debt rather than refinancing existing debt. This will ultimately have a positive impact on the free cash flow as well as the interest expenses will decrease.

However, it’s also dangerous to leave too much cash on the bank account of a company operating in a capex-heavy environment. I can imagine BWO’s management could be getting nervous with $1B in cash on the bank (because that’s what the cash position is evolving to), so we need to avoid them to rush into new development projects at any cost.

Fortunately the refinancing of the existing bonds also includes prepayment options in 2020 and 2021, and I think BW Offshore should most definitely repurchase as much of the bonds as possible and perhaps open a tender offer to reduce its interest expenses (during FY 2018, BW Offshore paid almost $80M in interest expenses on almost $1.4B in gross debt, indicating an average cost of debt of 6.5%. Needless to say, BWO will save tonnes of money by reducing debt.

The oil production is going well

Now we finally have clarity about the oil production. It does look like BW Offshore is taking the easy route and added the oil revenues to its consolidated revenue and EBITDA calculations. According to the segment information, the Exploration and Production (‘E&P’) segment contributed $28.6M in revenue, which is pretty much the result you’d get by multiplying the lift of 504,000 barrels net to the BW partnership with the $56 received per barrel of oil.

The Dussafu oil project appears to be immediately profitable. The production cost (before government royalties) was just $23/barrel, so every barrel of oil added value to BW Offshore, and the oil production added just over $21M in EBITDA for the quarter (note, this is the contribution of the BW Energy joint venture. The net attributable EBITDA result to BW Offshore is 2/3 rd of this result, so roughly $14M. A very profitable oil project indeed, and that’s very likely why Tullow Oil is also exercising its back-in right to acquire 10% of Dussafu. Once both the government of Gabon and Tullow Oil exercise their rights, the BW Energy partnership will own a 73.5% interest in the Dussafu license. This will result in an effective ownership of 49% for BW Offshore. Fine with me, as it also means Tullow Oil will have to pay for its of the Phase 2 development expenses.

Source: BW Offshore presentation

The recent purchase of a new oilfield

BW Offshore seems to think it can replicate the success at its offshore Gabon oilfield as it announced last Friday after-hours it is spending US$90M to acquire an initial 70% stake in the Maromba oil field from Petrobras. Maromba has approximately 1 billion barrels of oil in place, and Petrobras and Chevron (CVX), which owns the remaining 30%, estimate approximately 100-150M barrels could be recovered. BW Offshore is trying to consolidate the ownership of the entire oilfield, but Chevron’s board still has to make a definitive decision to divest the asset.

This will increase the importance of the oil production business for BW Offshore, but it also means it could deploy one of its own FPSO’s for the job, thus reducing the amount of vessels waiting for employment. Of course, the initial oil production at Maromba is very likely still years away, but I think the market should be ‘cautiously optimistic’ about this acquisition.

But the jury’s out until BW Offshore releases more details on its expected investment program to develop the Maromba oilfield.

Investment thesis

The net debt remains high at $1.23B, but this now represents just 2.5 times the full year 2018 EBITDA, and the debt ratio will decrease as the EBITDA should increase in 2019 while the net debt should decrease to $1.05B. I’m reasonably certain to see a debt ratio of just 2 by the end of this year.

300M USD in free cash flow would be approximately 2.55B NOK, or in excess of 13 NOK/ So yes. I still think BW Offshore is incredibly undervalued, but it will still need to deal with its contract renewals before the market will reward BW Offshore for it.

Other news from Europe

Michelin (OTCPK:MGDDF) (OTCPK:MGDDY) likes to spend its incoming cash flow on things to further strengthen the company’s business profile. Last week, the French tire giant spent $480M to purchase an 88% stake in PT Multistrada, an Indonesian peer of the company. A solid move, as this appears to be an excellent bolt-on move, further strengthening its presence in the Asian market as Multistrada has a production capacity of 11M passenger car tires, 250,000 truck tires and 9M tires for two-wheel vehicles. It’s interesting to see Michelin describe the output at Multistrada to be Tier 3 tires, and the production quality will be upgraded to Tier 2 tires, which should probably have a positive impact on the profitability and margins.

In Norway, the sovereign wealth fund will sell its positions in ‘pure’ oil and gas producers but will maintain its stakes in energy producers that also include downstream divisions. According to a statement of the fund, the stakes in pure oil and gas producers would be gradually reduced (so it doesn’t look like the sovereign wealth fund wants to shock the market), but its larger positions in for instance Equinor (EQNR), Total (TOT), BP (BP), and Royal Dutch Shell (RDS.A) (RDS.B) would be kept in the fund as these companies have a larger relevance.

The move is intended to reduce the Norwegian exposure to the volatility on the oil and gas market, as the country already generates a substantial part of its tax income through oil-related activities, it wanted to make sure it wasn’t over-exposed to the sector by also investing too much in it.

In the UK, the soap to gain control of Debenhams (OTC:DBHSF) (OTCPK:DBHSY) is far from over as Mike Ashley has launched a new attempt to take control of the struggling retailer which released another profit warning. Ashley is very likely planning to combine Debenhams with House of Fraser, another retail chain Ashley has purchased out of bankruptcy. Ashley appears to be serious about his attempts to gain control at Debenhams, as he has pledged to give up his executive roles at Sports Direct (OTCPK:SDIPF) (OTCPK:SDISY) where he owns an absolute majority of the shares.

Belgian beer giant AB InBev (BUD) is looking for a new chairman as its most recent chair of the board has resigned to focus on his main job at JAB holdings. Thierry Goudet will vacate the position at the brewer’s next AGM in April.

Raiffeisen Bank (OTCPK:RAIFF) (OTCPK:RAIFY) was knocked out last week when it was alleged to have laundered money for some Russian clients. The Hermitage Fund (managed by Bill Browder, whose book I strongly recommend) filed an official complaint with the Austrian authorities. It looks like Europe is once again the hot spot of money laundering issues as several high-ranking banks including ING Group (ING) and Deutsche Bank (DB) have been named in the scandal. It will very likely take years before it becomes clear what has exactly happened. And of course, the decision of the European Central Bank to further postpone rate hikes to normalize the monetary policy hasn’t helped the European banks either.

French hotel operator Accor (OTCPK:ACRFF) (OTCPK:ACRFY) has initiated a third tranche of its buyback program. After having bought 350M EUR in stock in 2018 and 250M EUR in the past few months, the hotel group has signed an agreement to repurchase an additional 250M EUR of stock. Once this buyback will be completed, Accor will have spent 850M EUR of the 1.35B EUR earmarked for buybacks. As the company’s price has lost in excess of 10% in the last trading week, I wouldn’t be surprised to see Accor completing this new tranche before the summer.

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Disclosure: I am/we are long BGSWF, BUD, EQNR, MGDDF, TOT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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