RE: New Aton ABG report17 January 2006, Tuesday
Arawak Energy. An FSU growth story at a reasonable price
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This note on Arawak Energy, a rapidly growing oil producer operating in the former Soviet Union, represents the first publication of our new “Idea Alert” research product. Very often, as we are preparing a fundamental research note on an attractive company, the share price runs away while we are putting the final editorial and layout touches on the note. To shorten the time between idea identification and its communication to clients, we intend in the future to issue short “Idea Alert” reports, in which we will profile a new stock/investment theme as well as provide preliminary financial estimates and valuation results. While such notes may or may not carry an official recommendation or be followed by a full report, we hope they nonetheless will serve as a useful early idea identification tool.
Arawak Energy Corp. is a Canadian listed company operating through subsidiaries in three CIS states: Russia, Kazakhstan and Azerbaijan. In Russia, Arawak owns 50% of Pechoraneftegaz, the license holder for the East Sotchemyu-Talyu field with 2P reserves of 26mn bbls and average 2005 production of 6mbpd. In Kazakhstan, Arawak produces crude oil through a 100% subsidiary from the Akzhar, Besbolek and Karataikyz fields, with an aggregate 2P reserve base of 27mn bbls and total current production of 3.2mbpd. In Azerbaijan, Arawak has a 29.74% interest in the South West Gobustan PSA covering three blocks of oil & gas fields with total 2P reserves of 32.5mn boe net to Arawak. Arawak’s total 2005 exit production stood at 6.3mbpd and the company reported total net 36mn bbls of proven and 73mn bbls of 2P reserves.
We expect Arawak to deliver very strong production and earnings growth in 2006, driven primarily by its Kazakhstan operations. The company’s combined production averaged 5.78mbpd in 2005 and in 2006 is expected to reach 9.4mbpd. In addition to that, Arawak’s Azerbaijan JV is anticipated to produce and sell 0.1bcm-0.4bcm of natural gas. This should bring about 89% growth in revenue, 115% growth in EBITDA and a 160% increase in net income. We note that Arawak’s Kazakhstan operations are grandfathered under the previous, more lenient (i.e. non-progressive) tax regime, which results in materially higher profitability compared to Russian/non-grandfathered Kazakhstan contracts. Arawak’s interests in Azerbaijan are also shielded from any adverse tax changes by a PSA contract.
Trading at 4.7X 2006F EBITDA, 3.7X 2007F EBITDA and $4.6/boe of 2P reserves, we feel the market is not giving full credit to Arawak’s growth potential. Since most of Arawak’s reserves are outside of Russia and enjoy tax-advantageous status, we believe its reserve multiple should converge with the PKZ/Nelson takeout multiples of $7-$8 per barrel of 2P reserves. Our preliminary DCF model (based on fairly conservative production estimates) yields a fair value of $2.8, or 44% upside potential. Our asset-based approach yielded a $2.39 fair value target, implying 23% upside. We thus highlight Arawak Energy as a very interesting mid-cap FSU growth story currently available at very reasonable valuations.