Reiterate Hold. Gulf Keystone reported strong FY 19 financial results but, with Brent at US$20/b, they seem like distant memories of a glorious past. Today, the main questions are: 1) how long can the company sustain operating losses; and 2) will the Kurdistan Regional Government (KRG) continue to make payments in line with the recently amended schedule in this environment? Management’s answer is that, with US$164mn in cash and the cost-cutting measures already put in place, Gulf Keystone could operate for 12 months if Brent averages US$30/b and there are some payment delays. This assessment confirms our early estimates. The company has a hefty liquidity cushion and no debt repayments until 2023, but its opex, G&A and interest are covered at US$35/b, implying operating losses when Brent is below that level. The current shape of the Brent forward curve suggests that prices will recover to US$35/b this quarter. If this were to happen, Gulf Keystone’s liquidity would be sufficient to support the business during the period of low prices. We reiterate a Hold recommendation on the GULFKY 23s (Bloomberg mid-price – 84, YTM – 16.6%).
Low oil prices are manageable in the short term. We have updated our financial model to incorporate the most recent management guidance, including a 50% yoy reduction in capex to US$40mn-48mn and a 20%yoy reduction in opex and G&A. With investments largely put on hold and production guidance suspended, we no longer expect Gulf Keystone to increase production and see it flat yoy in 2020, at c26,300bopd. We also change assumptions about the average oil price to US$30/b in 2020 and US$40/b in thereafter. These and other changes (Table 2 on page 3) suggest that Gulf Keystone will burn cash in 2020, but could return to positive free cash flow in 2021. Cash reserves could support the company through the period of low oil prices until April-May 2021.
New payment terms and settlement of receivables. In April, the KRG changed the long-established payment schedule under which the oil companies receive revenues for their share of oil exports three months after the delivery to the KRG. A sharp decrease in the Brent price in March made it difficult for the KRG to settle receivables accumulated in November 2019-Februry 2020, when the benchmark traded at US$60/b. In April, the KRG paid the companies for March exports and plans to continue regular monthly payments in the first two weeks of the month following oil delivery. However, the US$73mn of November 2019-February 2020 receivables will not be settled at least until the end of 2020 or when oil prices recover to US$50/b. The positive development is that the KRG continues to demonstrate its willingness to pay; however, whether the region can deliver on its promises when prices are at multi-year lows remains to be seen.
At least US$34-35/b is necessary to break-even. Despite having one of the lowers lifting costs per barrel, Gulf Keystone’s oil sells at the highest quality discount to dated Brent among peers. This puts the company at a disadvantage when commodity prices are weak. After the FY 19 results release, we recalculated the company’s cash costs per barrel and estimate that Gulf Keystone requires a benchmark (Brent) price of at least US$34/b to cover lifting costs, G&A and interest expense and US$44/b to break even at the FCF level, after capex in 2020. We note that this is a higher estimate than the one we have used in recent reports. The difference is explained by a change in the assumption about the speed of adjustment of the discount to lower oil prices. Below, we present comparable charts for Gulf Keystone and its peers.
Strong FY 19 seems like the distant past. In FY 19, the company posted a 18% yoy decline in revenues to US$207mn and a 19% yoy decrease in EBITDA to US$123mn, reflecting lower oil prices and higher operating costs associated with the ramp up of production during the year. Debt remained unchanged at US$100mn and cash declined to US$190mn due to high capex and generous shareholder distributions through dividends and share buybacks.