Shares of Gulf Keystone Petroleum (LSE: GKP) are trading a tad lower at around 120p after the independent operator and producer in the Kurdistan region of Iraq released its half-year results this morning.
At one time the company was considered to have stellar potential. But overloaded with debt under previous management, it only survived the 2014-16 collapse of the oil price by shareholders suffering a painful debt-for-equity restructuring. Now languishing as a forgotten growth stock, I see the risk/reward balance as highly appealing for new investors today.
Transformed balance sheet
First and foremost is the transformation of Gulf Keystone’s balance sheet. A year ago – before the debt-for-equity swap – the company’s market cap was a mere £44m. But net debt was a whopping $500m (£373m) making the enterprise value (EV) £417m.
Today, the market cap is £275m. But with the company reporting net debt of just $2m (£1.5m), the EV is less than £277m. So, we now have a company with an infinitely stronger balance sheet valued £140m cheaper than the former basket case.
Improved prospects
Gulf Keystone’s prospects have also improved in a number of other ways. The defeat of Daesh in nearby Mosul is one positive and the improving oil price, although still volatile, is another.
The company achieved average production of 36,664 barrels per day (bopd) during H1 and management reiterated full-year guidance of between 32,000 and 38,000 bopd. H1 gross operating costs per barrel were down to $3 from $4 and the company was cash flow positive through the period. Its Shaikan field remains a stable and predictable asset, set to produce for many decades to come.
With its strong balance sheet and positive cash flow, Gulf Keystone is now in a great position not only to make further investment to maintain plateau production at the nameplate capacity of 40,000 bopd, but also to increase production to 55,000 bopd and, in due course, higher still.
Stumbling block
The stumbling block at the moment is that while the Kurdistan Ministry of Natural Resources (MNR) is making regular payments to Gulf Keystone, these fall short of the contracted sums. The company estimates it’s owed a net $33m with regards to unpaid export sales (up from $25m at 31 December) and $76m net for past costs (up from $71m).
Management is reluctant to invest to increase production in these circumstances but continues what has been a protracted dialogue with the MNR “with the objective of achieving contractual and commercial clarity.” Encouragingly though, the board said today that it “notes the recent positive developments regarding the commercial terms agreed between the MNR and other international producers and draws comfort from this positive momentum.”
Favourable risk/reward ratio
The ongoing geo-political uncertainty in the region – one of the things impacting on negotiations with the MNR – makes Gulf Keystone a higher-risk proposition and not a stock for risk-averse investors. However, there’s nothing new in this regard. What is new is that the company is now far stronger and the stock far cheaper, making the risk/reward ratio considerably more favourable than in the past. As such, I rate the shares a ‘buy’ at their current level.
