We initiate coverage of the GENLLN 22s with a Buy recommendation. Our view is based on the company’s strong cash flow generation, resilience to cost inflation and oil price volatility, abundant liquidity and low leverage. We estimate that, as long as 1) Brent stays above US$40 per barrel, 2) the dividend policy is not in conflict with creditor interests and 3) timely payments from the Kurdistan Regional Government (KRG) keep coming, Genel will likely maintain its net cash position in 2022. The GENLLN 22s (YTM -8.47%, +656bps z-spread) have lagged the recent sovereign rally and, in spread terms, are indicated close to their widest levels over the IRAQ 23s in the past 12 months. The recent underperformance of the GENLLN 22s strengthens our view that this is a buying opportunity for investors comfortable with Kurdistan risk.
A pure-play Kurdistan exposure. Genel is an independent oil and gas company that has operated in the Kurdistan Region of Iraq (KRI) since 2002. It is at the forefront of the exploration and development of the region’s vast hydrocarbon reserves and has benefited from the lucrative terms of the production-sharing contracts (PSCs) for its key assets – the Tawke (operated by DNO) and Taq Taq oil fields. The company’s proved and probable (2P) reserves stand at 155mmboe and could secure another 11 years of production at the 2019 lifting rate of 37kboepd. The company has a portfolio of licenses at different stages of exploration and appraisal that should allow to replace its reserves (replacement rate >100% in 2018).
High cash flows at low cost. Genel is highly profitable at the current Brent price. We estimate the company’s production costs – including liftings, capex, interest and corporate overheads – amounted to US$43 per entitlement barrel, allowing the company to retain some US$29/boe in 2018. Incorporating management production and capex guidance into our financial model, we estimate that, in 2019, Genel could retain cUS$18 from each barrel of oil entitlement, generating cUS$126mn of free cash flow. This margin gives the company a degree of protection from oil price volatility and allows for potential cost increases from capex or dividends.
High liquidity and low debt. Genel’s only debt is the US$300mn of bonds due at end-22. The company had accumulated US$334mn cash by end-18 and, according to our estimates, will continue to build up cash reserves in 2019. If 2019f-22f capex remains at US$150mn and Brent is US$40-60/bbl, we estimate that, by end-22 (when the bonds are due), the company could repay debt from its US$340mn-580mn of accumulated cash reserves and should have no problems refinancing it.
Risks. There are some uncertainties around our forecast: 1) the newly introduced dividend policy requires a minimum of US$40mn annually – an increase in dividends above the minimum level could reduce the liquidity pool; 2) higher-than-projected capex could take a toll on cash balances; and 3) Iraqi politics (specifically, the KRG-central government relationship) and the regional security situation could undermine the assumption that oil and gas companies operating in the KRI will continue to receive regular payments from the KRG.