We reiterate our Sell recommendation on NOGLN 22s and NOGLN 25s following a weak 2020 production guidance, a warning of a substantial reserves downgrade and a lack of bidders for the company or any of its assets. NOGLN 22s and 25s are indicated at a price of 43-44, having lost 7-9pts in the last three days. We think that the longer the company waits to initiate a formal restructuring process with bondholders, the lower the potential recovery rate (or the market perception of it) would be. High rate of production decline and failing attempts to stabilise it puts the spotlight on the “going concern” question. If oil prices stay above US$50bbl, we expect US$100mn cash reserves to help Nostrum to muddle through 2020 in a cost-saving mode. However, we believe that with current level of production the business model is not sustainable in the long term, making bond restructuring imminent and potential recovery difficult to quantify.
2020 production guidance suggests c30% yoy decline to 20,000boepd. Nostrum started 2019 with what looked like a conservative production guidance of 30,000boepd and hydrocarbon sales guidance of 28,000boepd. As 2019 ended, no additional volumes came from drilling activities in line with management guidance, but the production decline rate exceeded expectations and the company updated its full-year sales forecast to 27,000boepd. Having completed reservoir studies, the company decided to halt drilling in 2020 and explore technological solutions to address challenging (declining) well productivity and finding a way to monetise its reserves.
Upcoming downgrade of 2P reserves. Another outcome of the reservoir studies undertaken last year is a significant downgrade in 2P reserves. The actual number will be disclosed when the FY 19 financial results are released, but management has already indicated a significant reduction of 2P reserves and a big impairment charge on the back of it. Nostrum has already downgraded reserves. The company started 2019 by announcing a 16% cut in 2P reserves to 410mmboe. Ongoing production challenges and downward reserve revision will further dilute operating viability of the business and consequently, potential recovery for bondholders in the case of a default.
Restructuring countdown begins. Based on the 20,000boepd production guidance (19,000boepd sales) and an average oil price of US$60/bbl, Nostrum could generate US$123mn operating cash flows in 2020. Considering a hefty US$86mn annual interest payments, the company would be left with US$37mn to spend on capex. This amount could finance a small drilling/workover programme before the company has to start spending cash reserves. According to management, the company will aim to maintain US$75mn cash on its balance sheet by the end of 2020. Our quarterly financial forecast (Table 1) and FY 20 forecast tested under different oil price assumptions (Table 2) suggest that Nostrum could survive 2020 if production meets management guidance, oil stays above US$50/bbl and capex does not exceed US$40mn. However, if in 2020 Nostrum does not reinvent itself as a midstream Oil&Gas company or finds a way to stabilise production, 2021 could become a moment of reckoning.
Recovery unlikely to exceed 50 cents on the dollar. Recovery analysis at current stage is complicated. With a declining production profile, falling reserves and still unsurmountable reservoir challenges, Nostrum’s future cash flow prospects have deteriorated to a point where they offer little value in potential restructuring negotiations. The recently commissioned gas treatment unit (GTU-3) cannot realise its full potential because of declining gas supplies from Nostrum’s own production and a lack of third-party feedstock. Equity upside could be realised if Nostrum reinvents itself as a midstream Oil&Gas company on the basis of its gas treatment capacity. Finally, GTU-3 could be sold to a third party, however, the price is a big question particularly in the absence of gas supply contracts. In a simplistic recovery analysis based on GTU- 3 valuation at cost (cUS$550mn), Nostrum’s cash and net working capital, but ignoring reserves and other assets, we estimate the highest recovery at 59 cents on the dollar if restructuring happened today. However, with a 25% discount to the asset value, our recovery estimate reduces to 44 (Table 3), roughly in line with mid-market indicative prices
No bidders for Nostrum’s assets. The company started strategic review and a formal sale process in June 2019. However, according to a recent press release, Nostrum has not received any bids on the company or any of its assets. This is bad news for the bondholders. The recently commissioned GTU-3 with installed capacity of 4.3bcm is viewed as a valuable asset for debt restructuring purposes. The company spent cUS$550mn to build it. However, low capacity utilisation of the facility due to insufficient and declining volumes of own production and an absence of third-party feedstock puts a big question mark on the fair value estimate of GTU-3.