Where’s the good news within Afren (LSE: AFR)’s story? Well, I don’t think that its shares necessarily offer incredibly poor value for money right now, based on certain assumptions, although some short-term losses could be on the cards.
The bad news, however, is that I need more evidence from its management team in order to assess the fair value of its equity — and even at 1.85p a share, its stock is not an obvious buy.
But such a call does not hinge on its restructuring plan.
Deal Or No Deal?
While a debt-for-equity swap remains the most likely scenario — as Afren says, that is “the only opportunity to realise value and participate in the recovery of the group” — it’s now time to stress test assumptions, projections and other data.
So, this is the starting point: Afren hit a stumbling block in 2014, when it recorded a whopping net loss of $1.6bn, mainly “due to a reduction in revenues given the fall in oil prices, a material impairment charge of $1.1bn in respect of the carrying value of the company’s production and development assets and the impact of the curtailment of future capital expenditure on our exploration“.
The oil producer is looking to exploit its lower cost production capacity in its Nigerian portfolio and it is focused on delivering on this strategy. To achieve that, it has lowered its full 2015 capex to $400m, which is way below average, based on its trailing financials.
In normal times, hence before 2014, Afren used to generate revenues above $1.5bn, but its top line dropped to below $1bn last year. Using $1bn of sales as a base-case scenario, and assuming that its gross margin (sales minus costs of goods sold) stands at about 30%/35% (which is a conservative estimate), its adjusted operating cash flow, including depreciation and amortisation, should comfortably hover around $500m/$600m.
Assuming no changes in working capital (WC) — a negative impact from WC could be absorbed by net cash proceeds of $148m from its pending restructuring — Afren should be able to get very close to breakeven in the first year of trade post-restructuring, assuming the proposed capital structure.
On a pro-forma (“as if”) basis, this implies manageable net leverage of between 1x and 2x, depending on certain elements including operating costs.
At this point, you might smell the opportunity of becoming part of a success story that could deliver outstanding returns, and you may even be prepared to invest part of your savings in it right now.
Not so fast.
Problems
The problem, it seems, is that Afren has taken its eyes off the ball in recent times and its strategy may deliver incrementally lower returns, even assuming a neutral capital structure that does not impact much its operational performance.
While in the first quarter of 2015 Afren achieved an average net production of 36,035 bopd, which is above the guidance range of 23,000-32,000 bopd for 2015, the company “delivered revenue of $130m and operating cash flows before movements in working capital of $59m, down from $269 million and $169m respectively in Q1 2014“. On an annualised basis, these figures imply lowly revenues of $520m (down from about $900m in 2014) and operating cash flow of $236m.
That doesn’t look good, and although 2015 numbers may greatly differ from these suggested annualised figures, first-quarter results certainly send a warning to exiting and new investors.
The fall in revenues in the first quarter “was due to lower realised oil prices and production liftings from Ebok utilised to settle a net profit interest (NPI) liability which is part of the agreement“. And here’s the problem: the terms of the restructuring are stringent, and unless Afren can keep up with the good job that — barring 2014 — it did on the operations side in the past, in my opinion it will unlikely become an attractive investment for a very long time…