GNE - Genesis Energy

[huxley]

"Last month, NZX-listed Genesis Energy said it would buy NZ Oil & Gas' stake in Kupe for $171 million, which would lift its stake in the project from 15 per cent to 46 per cent."

Looks like another great article buy stuff reporters... : /

[Snoopy]

Note that the declared after tax profit for Genesis Energy over FY2016 was $184.2m. Yet the 'normalised profit' (repeatable profit, pulling out one off events), $95.2m is only a little more than half this figure!

Today I want to talk about the figure in the big box below: 3.9c.

	Interim	Final	Snoopy Modelled Kupe NPAT	Snoopy Modelled Kupe Oil D,D&A	Implied Gentailer NPAT	Total	Missing Other Capital Asset to Fully Fund Dividend
Declared Dividend	7.74c	7.74c				15.5c
Normalised earnings			2.6c		6.1c	8.7c
Implied Capital Dividend Component				2.9c		6.8c	3.9c

My heading "Missing Other Capital Asset to Fully Fund Dividend" implies that all legitimate ways to find this extra capital have been 'lost'. That is probably unfair in the case of Genesis Energy. There are various legitimate FY2016 historical transactions that I list below. These mean the cash / 'asset as good as cash' generating position of Genesis Energy is rather better that my $95.2m normalised net profit figure might suggest.

Normalised EBITDAF	$322.9m
add Emission Unit Trading Net Gain {$21.0m-$15.5m}	$5.5m
add One off Gain on value of Turbine Parts	$6.9m
sums to Declared EBITDAF	$335.3m
less Net Finance Expense ($2.0m - $65.2m)	($63.2m)
less Stay in business CAPEX	($3.9m)
less Software Amortisation	($9.9m)
less Establish a New Customer Acquisition associated Deferred Expense Balance	($3.9m)
add Net Conversion of Huntly Coal to Cash	$15.5m
less Income Tax @ 28% derived from Normalised EBITDAF	($37.0m)
less Change in fair value of financial instruments	($26.6m)
less Other losses	($3.0m)
Total: 'Profit + Unusuals + Net harvested Depreciation, Depletion & Amortisation '	$203.4m

Note that $203.4m spread over one billion Genesis Energy shares on issue = 20.3cps. This neatly covers the 15.5cps (after tax) interim and final dividends paid for FY2016. So how Genesis Energy got to pay out a dividend equal to nearly twice their underlying profit is neatly explained. Yet the question remains for next year: Just how many of these 'behind the scenes' cash generators can 'work the magic' for FY2017?

SNOOPY

[Snoopy]

The acquisition is being funded by borrowings. Current borrowing costs average around 6%.

$168m x 0.06 = $10m.

Genesis are claiming that NPAT for FY2017 will increase by $2m after funding costs. So the forecast FY2017 "overall increase before interest costs and tax on that $2m extra profit" (change in EBIT) must be a gain of $10m+ $2m +0.28x $2m = $12.5m.

I have been running the numbers for income statement comparison purposes.

	FY2016 31% Kupe owned as published	Difference	FY2016 46% Kupe owned (future retrospective)
EBITDAF	$335.3m	+$39.0m (Genesis given)	$374.3m
Depletion, Depreciation & Amortisation	($127.7m)	-$14.9m (proportional increase on Kupe Assets)	($142.4m)
Revaluation of Generation Assets	$138.0m		$138.0m
Change in Fair Value of Financial Instruments	($26.6m)		($26.6m)
Other gains (losses)	($3.0m)		($3.0m)
EBIT (sub-total)	$316.2m		$340.3m
Finance Revenue	$2.0m		$2.0m
Finance Expense	($65.2m)	-$5.6m (adjustment made to fit)	($70.8m)
EBT (sub-total)	$253.0m		$271.5m
Income tax (calculated at 28%)	($68.8m)	-$7.2m (calculated difference)	($76.0m)
NPAT (total)	$184.2m	+$11.3m (Genesis given)	$195.5m

SNOOPY

[Snoopy]

Now I have the dividend information correct, the asset information and the association ratios dervied from that are best displayed separately in the table below:

	Assets	Normalised NPAT	PE Ratio
Share Price	$1.92	8.7c	22.0
Snoopy Kupe Value	$0.38	2.6c	14.6
Implied Value Genesis Gentailer	$1.54	6.8c	21.6

{Note that the $1.92 share price is a reference price taken during trading on the day I first did this calculation (4th November 2016) }

This gives a net earnings yield for 'Genesis Gentailler' of

6.8/154 = 4.41%

In turn this is equivalent to a gross yield of 4.41/0.72 = 6.13%

For gentailer, I regard a gross yield of 6% as 'fair' in today's market. So we can work out a fair share value of 'Genesis Gentailer' alone by ratio as below:

$1.54 x (6.13/6.00) = $1.57

To this we must add back the value of the Genesis stake in Kupe to arrive at a 'fair value' for the Genesis share price

$1.57 + $0.38 = $1.95

Note that the timing of this valuation (a month ago) was before Genesis announced that they would be buying the NZOG stake in Kupe.

I am using as my reference date 17th November 2016, the day after the purchasing of NZOG's 15% share in Kupe was announced. Note that the day before the larger shareholding in Kupe was announced the share price closed at $1.89.

	Assets	Normalised NPAT	PE Ratio
Share Price	$1.97	9.8c	20.1
Snoopy Kupe Value	$0.56	3.7c	15.1
Implied Value Genesis Gentailer	$1.41	6.8c	20.7

Notes:

1/ Incremental retrospective profit increase given by Genesis was $11.3m (referr to my previous post).

$11.3m/ 1,000m (shares) = 1.1eps (incremental). All of this incremental profit is derived from the increased share in Kupe.

2/ New 'Snoopy' Kupe field value is determined by multiplying by the ratio of the increased holding.

38c x 46/31 = 56c

Earnings yield for 'Genesis Gentailer' of

6.8/141 = 4.82%

In turn this is equivalent to a gross yield of 4.82/0.72 = 6.69%

For gentailer, I regard a gross yield of 6% as 'fair' in today's market. So we can work out a fair share value of 'Genesis Gentailer' alone by ratio as below:

$1.41 x (6.69/6.00) = $1.57

To this we must add back the value of the Genesis stake in Kupe to arrive at a 'fair value' for the Genesis share price

$1.57 + $0.56 = $2.13

SNOOPY

[Snoopy]

Notes:

2/ New 'Snoopy' Kupe field value is determined by multiplying by the ratio of the increased holding.

38c x 46/31 = 56c

<snip>

For gentailer, I regard a gross yield of 6% as 'fair' in today's market. So we can work out a fair share value of 'Genesis Gentailer' alone by ratio as below:

$1.41 x (6.69/6.00) = $1.57

To this we must add back the value of the Genesis stake in Kupe to arrive at a 'fair value' for the Genesis share price

$1.57 + $0.56 = $2.13

I am a little uncomfortable about my $2.13 'fair valuation' price for Genesis Energy.

The first reason why is that my valuation is from a perspective 'looking forward', assuming Genesis owned 46% of Kupe going into the FY2016 financial year (July 2015). Not only did Genesis not own 46% of Kupe at that point. There was no hint from an investor perspective that they would. Indeed I would speculate that this decision (to increase the Kupe stake) was the work of new CEO Marc England, who only took up his position in May 2016. That means my 'valuation' was on the basis of facts that only became knowable with hindsight.

The second problem is that Kupe was being depleted and surplus cashflow (not profit) was being distributed to shareholders as 'unimputed dividends'. Thus by the end of FY2016, the depletion of the resource should have been taken off my total capital valuation of Kupe. This I did not do. But complicating the 'end of financial year' resource valuation, was the fact that Kupe reserves were officially upgraded by 34.75% on 28th October 2015. I did not take this into account in my valuation process either! Bizzarely, my two 'errors' in effect, have nearly cancelled each other out. So my valuation at $2.13 looks roughly right, even if the method of obtaining it was ropey. It is very unlikely the reserves at Kupe will be upgraded during FY2017 as well. So this is definitely a live issue going forwards. And it is actually the FY2017 valuation going forwards that is of interest to investors!

SNOOPY

[Snoopy]

What follows below is a look at the oil and condensate slated for production, but this time using the production schedule graphed in the FY2016 NZOG annual report.

Year	No. of Oil & LPG	Oil Barrel	Kupe Condensate	Resource Depreciation	Net
	Equiv barrels	Price USD	Revenue	and Amortization	Proceeds
2017	640000	57.01	$54,782,462	$15,335,747	$39,446,715
<snip>
Total (2017-2028)	4.8505E06		$260,924,098	$96,487,745	$164,436,353
PV per share					$0.16
PV per share (tax paid)					$0.12

Time to rerun the Kupe valuation model (natural gas component) , this time using the 2P production chart in the NZOG FY2016 annual report.

Year	Kupe Gas	Value	Resource Depreciation	Net
	(GJ)	Received	and Amortization	Proceeds
2017	5.80E06	$38,616,400	$15,364,253	$23,252,147
<snip>
Total (2017-2028)	6.79E07	$315,921,673	$96,667,090	$219,254,583
PV per share				$0.22
PV per share (tax paid)				$0.16

The second problem is that Kupe was being depleted and surplus cashflow (not profit) was being distributed to shareholders as 'unimputed dividends'. Thus by the end of FY2016, the depletion of the resource should have been taken off my total capital valuation of Kupe. This I did not do.

It is now time to calculate the expected field depletion of the Kupe resource over the FY2017 year. The method is fundamentally a simple subtraction. All I have to do is take the total field resource, and take away from that number the resource that will be extracted over the FY2017 year. There is a small complicating factor. The field resources going into the future are discounted to reflect the 'time value of money'. We have moved forward by one year as we move from EOFY2016 to EOFY2017. This means that one years worth of discounting has to be removed from the remaining total. A 7% discount (the figure I have used) can be removed by dividing by the factor:

(1-0.07) = 0.93

I have reproduced above the relevant parts from my 'oil' and 'gas' production tables based on the Kupe field extraction profiles as suggested in the NZOG FY2016 report. So now we have all the figures needed to make the depletion over FY2017 calculation.

Part 1/ Oil Bit

($164,436,353 - $39,446,715)/ 0.93 = $134,397,440

Part 2/ Gas Bit

($219,254,853 - $23,252,147)/ 0.93 = $210,155,598

Adding up the EOFY2017 value of the field remaining from parts 1 and 2:

$134,397,440 + $210,155,598 = $345,153,058

Divide that by the billion Genesis Energy shares on issue and this equates to 34.5cps.

However, those workingsare all based on Genesis holding a 31% holding in Kupe. If they 'go according to plan' and acquire the NZOG 15% stake bringing their total Kupe holding up to 46%, then the Genesis Energy share of the Kupe field increases in value in proportion to the increased shareholding:

34.5cps x (46/31) = 51cps

In my previous post 2134, I calculated the value of 46% of the Kupe field at SOFY2017 at 56cps.

This means from a Genesis Energy share perspective, Kupe is expected to deplete over the course of FY2017 at a rate of:

56cps - 51cps = 5cps.

SNOOPY

[Snoopy]

6.8/141 = 4.82%

In turn this is equivalent to a gross yield of 4.82/0.72 = 6.69%

For gentailer, I regard a gross yield of 6% as 'fair' in today's market. So we can work out a fair share value of 'Genesis Gentailer' alone by ratio as below:

$1.41 x (6.69/6.00) = $1.57

To this we must add back the value of the Genesis stake in Kupe to arrive at a 'fair value' for the Genesis share price

$1.57 + $0.56 = $2.13

SNOOPY

This means from a Genesis Energy share perspective, Kupe is expected to deplete over the course of FY2017 at a rate of:

56cps - 51cps = 5cps.

IF:

1/ We assume that Genesis Energy can maintain their interim and final dividend of 8.2cps franked at 80% (which is what thay did over FY2016), AND
2/ that the purchase of the 15% equity stake in Kupe from NZOG is completed, boosting the total Genesis stake in Kupe to 46%.

THEN, taking account of the expected field depletion over the year, we can finally work out 'fair value' for Genesis Energy on the market today:

$2.13 - $0.05 = $2.08

And what was the closing price of GNE shares on the NZX on Friday? Up 3c to $2.13.

That means all of my modelling of the Genesis Energy share price is spookily in the ballpark!

SNOOPY

[Snoopy]

IF:

1/ We assume that Genesis Energy can maintain their interim and final dividend of 8.2cps franked at 80% (which is what thay did over FY2016), AND
2/ that the purchase of the 15% equity stake in Kupe from NZOG is completed, boosting the total Genesis stake in Kupe to 46%.

THEN, taking account of the expected field depletion over the year, we can finally work out 'fair value' for Genesis Energy on the market today:

$2.13 - $0.05 = $2.08

And what was the closing price of GNE shares on the NZX on Friday? Up 3c to $2.13.

That means all of my modelling of the Genesis Energy share price is spookily in the ballpark!

A small shift in the ballpark with GNE shares clsoing just above $2 today. NZOG shareholders have approved the sale of their 15% Kupe stake with a decent 87% of shareholders voting 'yes'.

All good for GNE holders I think!

SNOOPY

[Hoop]

As the share price stands today the chart says the 8.2c dividend going ex-date on the 29th March will be enough to break GNE's technicals..To prevent this event happening, buyer demand must rise (OBV) enough to lift the share price to higher highs between now and the 28th March

The 2 TA indcators (remember many are unreliable when the share price flatlines (low volatility) I used is an oscillator MACD (better reliability in times of low volatility) and buyer/seller behaviour using the OBV...Both show a degree of negative divergence suggesting weakness and a higher chance that GNE technicals will break down and enter into a correction phase..

[Snoopy]

8.2cps (total dividend) = 6.56cps (imputed) + 1.64cps (unimputed)

Take tax at 28% off the unimputed part of the dividend and I get an equivalent net dividend of:

6.56cps + (1-0.28)1.64cps = 7.74cps

Using that figure to redo the above implied share price calculation:

(7.74 + 7.74) / s = 0.07 => s = $2.21

Of course this is the average forecast share price over a four year period.

From "p67 of 84" of the presentation (small print) "These estimates (EBITDAF for FY2017) are based on an average oil price of US$50.98/bbl for FY2017 and a NZD/USD cross rate of US69.4c". (This assumption makes a difference to the expected earnings from oil.)

Here is a share price path which satisfies Genesis's own forecasts:

Valuation date	Forecast Share Price
22-11-2016	$1.96
22-11-2017	$2.46
22-11-2018	$2.34
22-11-2019	$2.21
22-11-2020	$2.09

Dividends in FY2016 were 81.9% of free cashflow, up from 80.9% in FY2015. But look at the 'Balance Sheet Capability' slide (p62 of 84) for the 22-11-2016 presentation. On the bottom RH corner of thet page is the forecast 'dividend payout ratio' as a percentage of 'Free Cashflow'. The graph has no scale. But there is a clear dip in the payout ratio in FY2018 should the buyout of the NZOG Kupe stake go ahead. Evidence perhaps that dividends may hold for FY2017, but may shrink from FY2018 onwards?

The above information was derived from Genesis Energy's 22nd November 2016 presentation to shareholders. This presentation was made just after the announcement of Genesis acquiring the Kupe shareholding of NZOG.

I have been reviewing my portfolio of high yielding shares, and for each one asking the question:
"As interest rates rise, can this company provide sustainable growth to boost dividends?"

I think looking further than twelve months out, the answer for Genesis Energy is 'no'. So I am now off the share register, having effectively preinvested my original Genesis Energy capital back into Contact Energy over the last couple of years.

All the best to shareholders that remain. Genesis has become much more a play on the price of oil and gas going forwards, so my $2.10 exit may yet prove premature. But I didn't buy Genesis Energy to start speculating on the oil price myself.

My investment in Genesis Energy has been highly educational. I knew little about how to value an oil field before I acquired my Genesis holding and have since learned a lot. It has also been a highly profitable investment, as I have held since the discounted IPO and banked all the bonus shares and dividends that have been forthcoming since float date.

What Genesis Energy management have done with what started out as a 'rag tag of assets', back when recently departed CEO - Albert Brantley - first came on board, I think is amazing. But I can't quite make the future vision for Genesis add up in sustainable 'eps' and hence 'dps' terms. So time to bank what management have done for Genesis Energy 'so far' and move on.

SNOOPY