Elk Petroleum — Update 26 August 2016

Elk Petroleum

Grieve fully funded

Grieve financing secured

Oil & gas

26 August 2016

Price	A$0.08
Market cap	A$53m
A$/US$ = 0.77
Net cash (A$m) end June 2016		18.1

Shares in issue	672.3m
Free float	57.5%
Code	ELK

Primary exchange	ASX
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	9.9	(6.5)	(13.2)
Rel (local)	9.4	(9.7)	(20.7)

52-week high/low

A$0.11

A$0.06

Business description

Elk Petroleum is an enhanced oil recovery (EOR) company. This technology achieves low-cost tertiary recovery of residual oil. Elk’s first project at Grieve in the US is targeted for first production in late 2017. There is a significant opportunity to apply EOR in Australasia, Indonesia and Malaysia.

Next event

FY16 full year results

Sep 2016

Analysts

Ian McLelland	+44 (0)20 3077 5756
Peter Chilton	+61 (0)2 9258 1161

oilandgas@edisongroup.com

Edison profile page

Elk Petroleum is a research client of Edison Investment Research Limited

Elk Petroleum has completed the restructuring of its JV agreement with Denbury Resources for its 12.3mmbbls 2P Grieve enhanced oil recovery (EOR) project. A substantial equity plus debt injection in June/August 2016 will fund the Grieve project to first production in late 2017 or early 2018, with Denbury covering any cost overruns. Including additional equity from a shortfall placement, we estimate a base case valuation for Elk based on 2P reserves of A$0.15/share, with upside from both 3P reserves (an additional A$0.06/share) and 3C contingent resources (an additional A$0.17/share).

Year end	Revenue (A$m)	EBITDA (A$m)	PBT* (A$m)	Net cash/ (debt) (A$m)	Debt (A$m)	Capex (A$m)
06/15	0.0	(3.1)	(3.6)	(20.9)	(22.5)	2.6
06/16e	0.0	(3.9)	(4.9)	18.1	0.0	(0.6)
06/17e	0.0	(3.8)	(3.7)	(24.0)	(24.0)	(49.7)
06/18e	38.0	24.5	8.6	(32.0)	(32.0)	(25.0)

Note: *PBT is normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Restructuring complete

Elk has completed the restructuring of its JV agreement with CO2 EOR specialist Denbury for its Grieve oil development, increasing Elk’s entitlement interest in the project from 35% to 49%. Once in production in late 2017 or early 2018, Elk will receive 70% of the first 2mmbbls of production, while enjoying the benefits of low cost CO2 feedstock (to cover the field 2P reserves) and additional income from Elk’s 100% owned oil export pipeline.

Funding secured, overruns protected

Elk has secured a US$58m debt facility from US-based Benefit Street Partners (BSP) to fund the outstanding capex to get to first oil (US$55m net to Elk). In addition, Elk raised c A$20m of new equity in June 2016 with subscriptions received for a further c A$11m from Elk’s entitlement offer shortfall placement. We estimate this funding will provide Elk with c US$12m of headroom on its debt facilities at peak debt ahead of first production. Elk has implemented a substantial hedging programme to cover its debt exposure that we expect to be repaid out of cash flows from the first c 2mmbbls of gross production. Denbury will also cover any cost overrun to first oil over and above Elk’s US$55m injection.

Valuation firms up with equity confirmed

Including the fresh equity that has been raised at A$0.075/share, we have updated our valuations for Elk. Our base case valuation for 2P reserves at Grieve on an unrisked and diluted basis (including the anticipated shortfall placement) is A$0.15/share, increasing to A$0.21/share if it can successfully develop 3P reserves. We also see upside in Grieve’s contingent resources, with an additional A$0.17/share possible through the development of the field’s 3C resources.

Elk Petroleum: Grieve development confirmed

Elk has completed the restructuring of its Grieve joint venture agreement with Denbury Resources and completed debt and equity financing to fund it through to production in late 2017 or early 2018. The restructuring confirms the arrangements initially announced in December 2015 whereby Elk will increase its entitlement interest in the field to 49%. Post royalties this equates to 2P reserves net to Elk of 5.3mmbbls, with the potential to also exploit possible reserves (3P net reserves are 7.0mmbbls) along with 7.0mmbbls of 3C net contingent resources.

In parallel with the restructuring deal, Elk has secured debt and equity funding that, with additional committed equity from the shortfall placement, will fully fund Elk’s capital requirements to first production. Furthermore, Elk is not exposed to overruns to first oil with its Grieve partner, Denbury Resources, covering costs overrun beyond a firm cap on Elk’s development costs.

Terms of the restructuring deal

Elk is increasing its entitlement interest in the Grieve field from 35% to 49% in return for a net investment of c US$35m. This entails Elk paying the remaining third of the Grieve development costs up to a cap of US$55m (Denbury will cover any cost overruns beyond this point). Denbury will also forgo recovery from Elk of c US$20m of previously carried costs associated with prior joint venture funding arrangements between the two parties for the Grieve development. Elk estimates the 49% interest being transferred from Denbury to Elk has an asset value of c US$60m.

Denbury will supply and cover all costs of CO2 up to first oil production, and any additional CO2 up to 82bcf will be provided at Denbury’s cost of CO2. Net of recycle, the 82bcf of CO2 supply is expected to be sufficient to extract 100% of the 12.3mmbbls of gross Grieve 2P reserves.

Elk will receive preferentially inflated cash flows from the first 2mmbbls of gross production at Grieve, namely 75% of the cash flow from the first 1mmbbls of gross production, and 65% of the cash flows from the second 1mmbbls of gross production. Elk will also enjoy revenue from gross production over the life of the project by earning a haulage charge of US$3/bbl (c US$19m for Denbury’s 51% retained interest) under a binding long-term regulated pipeline tariff to export Grieve production via Elk’s 100% owned export pipeline.

Financing: Debt secured, entitlement offer partially completed

Elk has secured US$58m of conventional term-loan oil field development financing from US based Providence Capital subsidiary, Benefit Street Partners (BSP) to fund its outstanding capital requirements to first oil. The company has not disclosed the terms of this funding but given the familiarity of CO2 enhanced oil recovery projects in the US, and with Denbury as operator, we would expect the terms of the loan to be fair and not distressed.

Elk has undertaken a substantial hedging programme to cover its development cost exposure at Grieve. Again, we do not have terms for this but we estimate that based on Edison’s oil price assumptions Elk should be able to pay down a substantial portion of its debt commitments by mid-2019 with the first c 2mmbbls of gross production.

In addition to debt, Elk has also raised substantial equity to fund it through to Grieve production. Up to August 2016 the company has raised A$30.8m in new equity, the majority coming from a partially underwritten 7.5c/share entitlement offer from the first tranche in June 2016, raising A$19.6m, and an additional A$11.1m through the placement of the remaining shortfall under the entitlement offer to sophisticated investors in August 2016.

Post the debt and equity raises described above, Elk has issued updated guidance on production. We have increased our forecasts to reflect these accordingly, in particular increasing our 2018 revenues to A$38.0m (from A$22.5m).

Elk exited FY2016 ending June 2016 with A$18.1m of cash and no debt (following conversion of A$3.6m of convertible debt in the previous quarter). The company can now draw down on its US$58m facility with BSP and expects to deploy A$30m of this in the coming quarter on Grieve capex. We estimate that peak debt prior to first oil in H217 is likely to be c A$60m (US$46m), giving Elk a comfortable US$12m headroom on its facilities.

Valuation: Entitlement offer firms up valuation potential

In our initiation note on Elk published in May 2016, a key uncertainty to the ultimate valuation for Elk shareholders was the share price at which equity could be raised to fund the Grieve development. In the June 2016 entitlement offer, equity was raised at A$0.075/share. Building this into our cases for 2P (our base case) and 3P reserves and the upside potential from 3C contingent resources, we suggest on an unrisked basis an updated valuation (on a diluted basis assuming the shortfall shares are issued) of A$0.15/share for the base case, A$0.21/share for the 3P reserves, and an additional A$0.17/share for the 3C contingent resources (Exhibit 1).

Exhibit 1: Elk valuation cases for 2P, 3P and 3C reserves and resources

	2P reserves	3P reserves	3C contingent resources
Grieve NPV (US$m)	80.2	118.4	84.3
Grieve NPV (A$m)	104.3	153.9	109.5
Singleton (book value) (A$m)	3.3	3.3
EV (A$m)	107.6	157.2	109.5
Net cash/(debt) end FY 2016 (A$m)	18.1	18.1	18.1
G&A (NPV 3 years) (A$m)	-8.7	-8.7
Elk capex commitments (ex Grieve) (A$m)	-3.3	-3.3
ELK valuation (A$m) (undiluted)	113.8	163.4	127.6
Current issued shares (m)	672.3	672.3	672.3
ELK valuation (A$/share) (undiluted)	0.17	0.24	0.19
Remaining shortfall capacity shares to be issued at 7.5c/sh (m)	148.5	148.5	148.5
Equity to be raised with shortfall capacity shares (A$m)	11.1	11.1	11.1
ELK valuation (A$m) (diluted)	124.9	174.5	138.8
Diluted issued shares (m)	820.8	820.8	820.8
ELK valuation (A$/share) (diluted)	0.15	0.21	0.17
A$/US$	0.77

Source: Edison Investment Research

Exhibit 2: Financial summary

	A$'000s	2014	2015	2016e	2017e	2018e	2019e
Year end June		IFRS	IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		327	38	38	38	37,972	57,244
Cost of sales		(803)	(264)	(300)	(300)	(9,970)	(12,331)
Gross profit		(476)	(226)	(262)	(262)	28,003	44,913
General & admin		(3,639)	(2,901)	(3,680)	(3,500)	(3,500)	(3,500)
EBITDA		(4,115)	(3,127)	(3,942)	(3,762)	24,503	41,413
Depreciation		(1,050)	(243)	(169)	(170)	(13,478)	(16,649)
EBIT (before amort. and except.)		(5,165)	(3,370)	(4,112)	(3,932)	11,025	24,764
Intangible amortisation		0	0	0	0	0	0
Exceptionals		(2,060)	0	(1,200)	0	0	0
Other		0	0	0	0	0	0
EBIT		(7,225)	(3,370)	(5,311)	(3,932)	11,025	24,764
Net interest		(122)	(276)	(742)	200	(2,405)	(3,197)
Profit before tax (norm)		(5,287)	(3,646)	(4,854)	(3,732)	8,620	21,568
Profit before tax (FRS 3)		(7,347)	(3,646)	(6,053)	(3,732)	8,620	21,568
Tax		0	0	0	0	253	219
Profit after tax (norm)		(5,287)	(3,646)	(4,854)	(3,732)	8,874	21,787
Profit after tax (FRS 3)		(7,347)	(3,646)	(6,053)	(3,732)	8,874	21,787

Average number of shares outstanding (m)		180.2	196.7	667.9	816.3	816.3	816.3
EPS - normalised (c)		(2.9)	(1.9)	(0.7)	(0.5)	1.1	2.7
EPS - normalised fully diluted (c)		(2.9)	(1.9)	(0.7)	(0.5)	1.1	2.7
EPS - (IFRS) (c)		(4.1)	(1.9)	(0.9)	(0.5)	1.1	2.7
Dividend per share (c)		0.0	0.0	0.0	0.0	0.0	0.0

Gross Margin (%)		N/A	N/A	N/A	N/A	73.7	78.5
EBITDA Margin (%)		N/A	N/A	N/A	N/A	64.5	72.3
Operating Margin (before GW and except.) (%)		N/A	N/A	N/A	N/A	29.0	43.3

BALANCE SHEET
Fixed Assets		20,176	28,979	29,481	79,036	90,583	73,935
Intangible assets		20,128	28,953	29,035	29,035	29,035	29,035
Tangible assets		48	26	446	50,001	61,549	44,900
Investments		0	0	0	0	0	0
Current Assets		3,261	2,549	19,085	982	5,473	13,782
Stocks		9	0	0	0	1,553	2,341
Debtors		35	168	168	168	3,106	4,683
Cash		403	1,567	18,103	0	0	5,944
Other		2,814	813	813	813	813	813
Current Liabilities		(5,216)	(11,548)	(4,377)	(4,377)	(3,624)	(5,463)
Creditors		(2,900)	(7,962)	(4,377)	(4,377)	(3,624)	(5,463)
Short term borrowings		(2,316)	(3,585)	0	0	0	0
Long Term Liabilities		(17,385)	(22,147)	(3,216)	(27,265)	(35,182)	(3,216)
Long term borrowings		(12,589)	(18,931)	0	(24,048)	(31,966)	0
Other long term liabilities		(4,797)	(3,216)	(3,216)	(3,216)	(3,216)	(3,216)
Net Assets		835	(2,167)	40,973	48,376	57,250	79,037

CASH FLOW
Operating Cash Flow		(3,712)	(3,337)	(4,684)	(3,562)	17,107	37,910
Net interest		0	0	0	0	0	0
Tax		0	0	0	0	0	0
Capex		(863)	2,560	(555)	(49,725)	(25,025)	0
Acquisitions/disposals		0	0	0	0	0	0
Equity issued		2,660	742	25,361	11,136	0	0
Dividends		0	0	0	0	0	0
Net Cash Flow		(1,916)	(36)	20,121	(42,152)	(7,918)	37,910
Opening net debt/(cash)		4,216	14,501	20,949	(18,103)	24,048	31,966
HP finance leases initiated		0	0	0	0	0	0
Other		(8,370)	(6,412)	18,931	0	0	0
Closing net debt/(cash)		14,501	20,949	(18,103)	24,048	31,966	(5,944)

Source: Edison Investment Research

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