JKX Oil & Gas Results Confirm Progress - Execution Must Continue

JKX Oil & Gas (LON:JKX) published its final results today — and it’s very much a case of so far, so good, for the Russia/Ukraine-focused company.

The financials were down slightly on last year and the company’s share price lost 7.7% to 70p, but in my view the results confirmed that the company is making progress with its plans and — so far — is delivering as promised.

The critical element this year will be whether the remainder of its plans for boosting production from its current assets succeed. Any failures could weigh heavily on the company’s cash flow and stock price, as last year saw an 8.4% fall in production to 8,281 boepd (2011: 9,045 boepd) that urgently needs to be reversed.

Russia vs. Ukraine

As I discussed recently, JKX’s efforts to increase production from its Koshekhablskoye gas field in Russia have been successful, to the point where it is having to increase the capacity of its gas plant.

Sales have now reached 40 MMcfd, maxing out the plant, but the company believes it can increase capacity to between 50 and 60 MMcfd without major expense or disruption. This is good news, but it’s worth pointing out that the company’s average gas sale price in Russia last year was just $2.60/MMcf, whereas in Ukraine it was $12.1/MMcf. This is a classic example of the localisation of gas markets — a complete contrast to the oil market.

This is also why JKX is shifting the bulk of its capital expenditure from Russia to Ukraine over the next couple of years, although the pending renegotiation of the gas supply agreement between the two countries (Russia supplies much of Ukraine’s gas needs) could also affect the prices achieved on JKX’s Ukrainian gas sales, as and when it concludes.

2013: What to watch for

When investing in a company like JKX, my goal is to identify a number of near-medium term factors that should deliver a material improvement in the company’s fortunes, and hence its share price.

The first of these was the acidisation programme for the Koshekhablskoye gas field, which has been successful and delivered increased production.

This is what I’m hoping to see over going forward in 2013/14:

• Completion of a fourth well at Koshekhablskoye and further production gains. The company’s target in Russia over the 2013/2014 period is focused on increasing gas delivery to 60 MMcfd at minimum capital cost.
• In Ukraine, a successful frac operation to release new reserves in well R-103 in the Rudenkovskoye field in the second quarter of this year. JKX says that it is “cautiously optimistic” the results of this will justify a further well and continuing development. The frac is due to take place in the next quarter and results should be available in the autumn.
• In Ukraine, some concrete progress with development drilling the fields operated by JKX’s Poltava Petroleum Company subsidiary (the Molchanovskoye, Elizavetovskoye and Zaplavskoye fields are lined up for drilling this year), as well as waterflood programmes on the Ignatovskoye and Molchanovskoye North fields. These are all relatively low production wells and presumably the drilling activity will be fairly low cost, too. It’s a case of maximising cash flow from old fields.
• Also in Ukraine, progress with execution of an upgrade to the LPG plant. JKX is targeting a 15% increase in LPG production. The necessary equipment has been shipped from Canada and is due to be installed in May 2013. If successful, this upgrade will raise LPG yield from 1.94 tonnes/MMcf of gas to 2.23 tonnes/MMcf.

Financial update

JKX continues to deal with the movable feast that is tax legislation in both Russia and Ukraine, but its overall financial situation has improved considerably, in my opinion.

JKX took an exceptional charge of £30.7m on its Russian Novo–Nikolaevskoye Complex and of $15.1m on its Hungarian assets in 2012, in both cases because of reduced reserves/falling production. 

Profit before these non-cash exceptional items was $51.6m (2011: $82.0m). The fall was mostly due to falling oil and gas production in Ukraine, something I hope to see reverse this year.

JKX’s 2012 profits equate to underlying earnings per share of 14.36 cents, or around 9.3p, giving a P/E of around 7.5 at today’s closing share price, and at about 32% of its tangible book value.

A short term and expensive swap-based borrowing facility for $50m was repaid last year and replaced with $40m of convertible bonds, which were issued after the year end and so are not reflected in the company’s accounts.

Although operating cash flow exceeded investing cash flow in 2012, JKX’s cash balance fell last year due to the repayment of its swap facility, leaving just $12.6m of cash at year end. However, this has since been supplemented by the $40m convertible bond issue and the group is fully-funded for the current operational programme.

Overall, I think it’s financial position is stronger than it was six months ago, but it will need to deliver the promised operating cash flow gains to consolidate this improvement.

Conclusions

I’m still happy holding JKX, and hope that it will continue to execute its programme to maximise cash flow from its existing assets. It’s not without risk, but then neither is crossing the road…

If you don’t want to read the entire results RNS, then there is a good presentation here on the company’s website.

Disclosure: Roland hold shares in JKX Oil & Gas.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any purchase decisions.