Post news last week on the new Shaikan sales agreement, the market seems slowly and begrudgingly to be accepting the continued rehabilitation of Gulf Keystone Petroleum and the transformation thereof of the company’s cash flow profile.

Looking at the RNS last week of the renegotiated crude oil sales agreement we believe the market continues however, even after the 10% re-rating, to dramatically underprice the stock. We make the point per below from the interim figures in Sept 17 regarding the company’s then net back profile  –

“The Group’s production is sold under its oil export arrangements with the KRG at a field-specific quality discount to the price of Brent crude oil and after transportation costs. The Group continues to assume Shaikan quality discount at $14.7/bbl and transportation costs at $5.2/bbl. Based on these assumptions, the realised price for 2017 export sales is estimated at $32/bbl (H1 2016: $20/bbl).

The RNS of last week stated – “Under the agreement, the KRG will purchase Shaikan crude oil at the monthly average Dated Brent oil price minus a total of c.$22 per barrel for quality discount, as well as domestic and international transportation costs.”

Taking the last 3 months Brent average price of circa $62/bbl produces an increase on this new formula of @ $10/bbl over the realised 2017 figure and so gives a net margin increase of almost 33% based on the company’s disclosed operating costs per barrel of oil. Additionally, we can deduce that the company’s cash flow estimates for 2018 will only decline in the event that the price of Brent oil falls below $54 per barrel ($32 + $22). Of course should oil continue its upwards trajectory then the net margins to GKP will expand further with the consequent benefits this creates re the planned capacity expansion at Shaikan.

From a balance sheet perspective, when we add in the $33m of arrears and $76m owed from the Shaikan Government Participation Option (SGPO) we believe the stock is trading on an EV:EBITDA multiple for 2018 (assuming an average price of $62 per barrel of Brent oil) of approx 3 times as EBITDA estimates look likely to rise to @ $80m and possibly higher. The numbers breakdown as follows:

Market Cap – $410m (based on $1.385 FX rate)

Plus : Debt – $100m

Less – cash end Dec 18 (estimated) – $150m

Less – $33m arrears

Less – $76m SGPO

EV = $251m

EBITDA potential for 2018 (based on $62 per boe Brent) – $81m (conservative)

Should the production expansion towards 55k bopd in 2019 which looks likely then the EV:EBITDA multiple will fall further.

We have long believed that since the company’s restructuring in late 2016 that the stock will be taken out and numerous names have been in the frame including SINOPEC of China and DNO who both operate in the region and in DNO’s case enjoys a much higher EV:EBITDA multiple making compelling logic for such an acquisition.

GKP is one of our key 2018 picks having a recommendation re-iteration at 97p at end Dec. We maintain the stock price should begin with a 2 and assuming a stable oil price backdrop and continued operational progress continue to believe the company a ripe acquisition target. We remain long and confident in our stance.

DISCLOSURE & RISK WARNING

Align Research & a Director of Align Research Ltd holds a personal interest in Gulf Keystone Petroleum and is bound to Align Research’s company dealing policy ensuring open and adequate disclosure. Full details can be found on our website here (“Legals”).

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• Gulf Keystone
• Oil