Pareto: Africa Energy spent USD 5m on the 2B compared to a negative valuation impact of USD 150m

Africa Energy announced dry well on 2B prospect. Pareto: “The Gazania-1 exploration well was dry, lowering our risked valuation by SEK 0.5/share or ~10%. We find the ~40% negative share price reaction excessive.. The main value driver in Africa Energy remains progress on the development of its discovered resources on Block 11B/12B offshore South Africa. To our understanding, operator TotalEnergies is pushing for the project to supply gas-to-power (better ESG story), prolonging time to reach a final deal on gas sales, now expected in early 2023. We find the current valuation to be an attractive entry point and think the current pricing can trigger M&A interest.

Pareto research front page summary:

Unfortunate, but no dealbreaker (BUY reiterated)
The Gazania-1 exploration well was dry, lowering our risked valuation by SEK 0.5/share or ~10%. We find the ~40% negative share price reaction excessive considering Africa Energy’s limited spend on the prospect (USD 5m cost vs USD 150m valuation impact). The main value driver in Africa Energy remains progress on the development of its discovered resources on Block 11B/12B offshore South Africa. To our understanding, operator TotalEnergies is pushing for the project to supply gas-to-power (better ESG story), prolonging time to reach a final deal on gas sales, now expected in early 2023. We find the current valuation to be an attractive entry point and think the current pricing can trigger M&A interest. BUY reiterated – TP down to SEK 3.60 (4.50) due to the dry well, higher WACC for all our covered companies and a potential modest funding need.  

Dry well at Gazania-1 exploration prospect
The exploration well targeting the Gazania-1 prospect on Block 2B offshore South Africa was dry. We valued the upside potential of SEK 2.5-3.0/share at SEK 0.5/share in our risked valuation (NAV), which makes the negative SEK 1.60/share price excessive in our view. For context, Africa Energy spent USD 5m on the well compared to a negative valuation impact of USD 150m. Garzania-1 should be seen as an option (created by AEC at limited cost) that disappointed, but now also creates an attractive entry point for due to the large share price decline.

Progress on the development of Block 11B/12B is still the main value driver
The main value driver in Africa Energy remains progress on the development of the vast gas discoveries offshore South Africa. We had hoped for a gas sales agreement this year after the Application for Production Right was submitted in Sept’22. However, our understanding is that operator TotalEnergies is pushing for improved economics and inclusion of gas to power as part of the development. Agreement is expected early next year. If realized, this will build a stronger ESG story as South Africa today gets 80-90% of its power from coal and are experiencing regular blackouts.

Target Price down to SEK 3.6/share – BUY reiterated 
We estimate Africa Energy’s risked valuation (NAV) at SEK 3.6/share based on a long-term gas price of USD 7/mcf in South Africa and WACC of 15%, which is up from 10% to reflect higher global interest rates. Still, this implies that Africa Energy trades at a 55% discount to our SOTP. Combined with increased interest for gas resources, we think this makes Africa Energy an increasingly attractive acquisition candidate. We continue to think that M&A is most likely post securing the gas sales contract which should also trigger a repricing of the stock. However, current strong energy prices may move potential M&A forward in time. Africa Energy had USD 7m of cash at the end of Q3 and Gazania-1 cost the company USD 5m due to extended drilling time (Africa Energy was carried by partners if drilling had stayed on time). This is likely to trigger a modest need for capital, reduced by the company’s low-cost base of USD 1.0-1.5m/quarter (1 year of G&A equal less than 3% of market cap), that we think can be easily secured form the company’s historically supportive shareholder base. We lower our TP to SEK 3.60 (4.50) and reiterate our BUY recommendation.

Disclosure: 

The goal of the blog is to provide investment ideas for further research. I/we have a beneficial position in the shares discussed above either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. The article does not represent investment advice. Please do your own research before making any investment action.

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