Fixed Income Analysis /

Nostrum Oil: Upside constrained by uncertainty

    Kiti Pantskhava
    Kiti Pantskhava

    Senior Credit Analyst

    Tellimer Research
    19 July 2019
    Published by

    Reiterate Hold. In July, S&P downgraded Nostrum Oil to CCC+ from B-, sending bond prices to their all-time lows. Bonds have recovered some of the losses since, but valuations remain cheap for a company that has no short-term liquidity issues and will be free-cash-flow neutral in 2019, according to our forecasts (Table 1). Uncertainty about future production and potential corporate transactions that could result in a change of control will continue to weigh over bond prices. We believe that at current levels, downside risk to NOGLN 22s and 25s is low and upside risk is high. The results of testing two new wells in the northern part of Chinarevskoye, a technical study of producing reservoirs in the north east and updates on a recently launched formal sale process are the next potential triggers. We reiterate our Hold recommendation on both bonds on cheap valuation.  

    Deeply NPV-negative scenarios are reflected in bond prices. NOGLN 22s and 25s trade at deeply discounted levels, which imply an imminent restructuring with NPV-negative consequences. We agree that under a range of visible future outcomes, Nostrum will have to refinance NOGLN 22s and 25s before their maturity. What remains to be seen is whether the company’s financial position and prospects at that point will allow a relatively straightforward refinancing with a maturity extension, or require an elaborate debt restructuring deal involving a haircut to the principle and alleviation of the interest burden. Assuming a 12% exit yield, we think current bond prices reflect 1) an extension of maturity to 2027-28 and, 2) a reduction of interest by 2-4ppts and up to a 30% haircut (Table 2).

    High visibility of 2019 production, but no outlook for 2019 yet. Nostrum’s 30,000boepd production guidance for 2019 is on the cautious side. It does not include any potential volumes coming from the 2019 drilling programme, but does reflect the natural decline rate of producing wells. The company’s daily flows were reported at 32,646 boepd in Q1 19 exceeding full-year guidance. Investors expect the company to release updated guidance and outlook for 2019, incorporating the results of the two new appraisal wells and findings of the technical study. The dates to watch are 30 July  and 20 August when H1 19 operating and financial results will be reported. However, given the history of delays in drilling, and the management’s newly adopted cautious approach to production guidance, it could take until end-2019 for any updates to be communicated.

    FCF-neutral in 2019. With production at 30,000boepd in line with guidance and Brent at ytd average of US$66/bbl, we expect Nostrum to be free-cash-flow-neutral in 2019 and retain cash balance aboveUS$100mn. According to our estimates, the FCF-breakeven oil price will be at US$68/bbl in 2019 and US$50/bbl thereafter, assuming only essential investments to maintain production at c30,000boepd are made (Table 3). We believe that the negative free cash flow in Q1 19 is not representative of the full year performance and is explained by a combination of interest payments (falling in Q1 and Q3) and a time mismatch between shipment and payment in the normal course of business. We expect Nostrum to maintain sufficient liquidity to stay current on its debt in 2019 and 2020 if production does not fall below 30,000 boepd and Brent is above US$50/bbl.

    Is the company on sale and/or ready for partnerships? In June, Nostrum disclosed that a strategic review was under way and that the sale of the company was one of several options being considered to deliver value to shareholders. Other potential transactions include entering into further throughput agreements, acquisitions of adjacent fields and farm-outs of stakes in some assets to speed up their development. The GTU3 project has been completed, but Nostrum does not produce enough feedstock to secure high capacity utilisation of the brand-new facility and does not have the financial capability to ramp up production volumes with Brent at US$60-65/bbl. If the company is sold as a whole or a substantially big part of the business is contributed to a partnership (which is unlikely to happen without a bondholders’ consent), there could be consequences for the bonds. NOGLN has a change of control provision, which kicks in if either a third party acquires all – or substantially all – of the property and assets of Nostrum, or accumulates 50% of the voting rights in the company. Such transactions could trigger a change of control put at 101. If the successful bidder is a big and financially strong oil & gas company, NOGLN 22s and 25s could have significant upside. If the successful bidder is not an obviously stronger entity, the uncertainty over repayment (refinancing) of the bonds could continue to weigh on valuations.