Rockrose Revisited At 1.5 Times Forecast Earnings

5th Mar '20 by Jack Brumby

10 comments 6858 reads

Since reaching a high of 2,230p on January 16th, the Rockrose Energy (LON:RRE) share price has tumbled by 35%. Today its market cap stands at £191m. Its recent update presentation shows a cash hoard of some $371m ($55m of which is restricted). Converted at current rates, that is £289m, or 151% of its market cap. Strip out the $55m of securitised cash, and the remaining $316m (£246.5m) is 129% of market cap.

Priced at just 1.5 times forecast earnings and 2.8 times trailing twelve month free cash flow, you’ll be hard pressed to find a cheaper stock than this North Sea oil & gas producer on an earnings and cash flow basis.

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When you find a company on this sort of valuation, usually it is either worth nothing or it is worth multiples of its current price.

Why is Rockrose so cheap? In a word: decommissioning. Rockrose is assembling a collection of mature north sea oil and gas operating assets. The key word here is mature. When oil and gas assets stop producing, wells need to be plugged up and pipelines must be cleaned. It’s an expensive business.

RockRose says in its most recent update to shareholders that it has an Abandonment Half-Life (the date at which half of RRE’s abandonment expenditure has been incurred) of 2030. Operators are quickly getting better at extending the lives of these assets, however.

The group says it has 82MMboe of 2P + 2C Reserves and is “designed to do business in the harsh environment of sub-$50 per barrel oil prices”. If you put that into practice then, and apply a price of $40 to its barrels of oil equivalent, you calculate that this £191m market cap company is sitting on about $3.28bn of proven and probable reserves.

RockRose could well be worth many times more than 1.4 times forecast earnings, but getting to grips with this quickly evolving company is tricky...

A step up in profitability... and uncertainty?

Halfway through 2019, RockRose purchased Marathon Oil. This was a material acquisition. Looking at the indicative financial statements presented in the 2019 prospectus (page 105), we can see that the Dyas and Marathon acquisitions would have changed FY18 income statement:

Revenue from $153m to $603m
Operating profit from $25m to $350m
Profit for the year from $39m to $230m

It also…

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SaarfLondon

5th Mar '20

Great coverage on this stock Jack - food for thought , been long a while since £6 days Heart skipped a beat as I only read the"share price has tumbled 35% " bit initially.

Michael Taylor

This is a hugely informative article Jack - thank you very much for posting. I was aware of decommissioning but you've got into a lot of detail of the subject.

I believe Andrew Austin is sitting just under 30% of the share price and so I think a share buyback would need to see him exempt from the City Code on Takeovers and Mergers. Do correct me if I'm wrong somebody but that is how I understand it.

I'm a big fan on share buybacks so long as the goal is to reduce shares in circulation rather than reduce them then award lavish options packages to management (which is surprisingly common).

Silver Moon

A very thorough delve into the business, thanks, Jack.

Jack Brumby

Thanks for pointing that out Michael, it slipped my mind that Austin owned such a large amount of the group's shares. Makes a lot more sense now.

When a stock is trading on such a low valuation, I'm happy to spend time going into more detail because there is clearly a potential opportunity... Plus with decommissioning set to be a multi-decade, multi-billion pound trend, getting to grips with it now could pay dividends in future as I imagine there'll be multiple opportunities around this theme.

Jock Ewing

Thanks Jack, nicely written article.

Would be interested in your perspective regarding the broader ESG angle here. The negative sentiment surrounding O&G companies in relation to the growing ESG theme feels like a larger concern to me for the sector.

Funds are progressively reducing their exposure to this sector and it's not obvious where the required catalyst for re-rates across optically undervalued stocks such as RRE and other O&G players is going to come from. My sense is that companies such as RRE will need to find a way to engage with the ESG sentiment to create a means for funds to re-enter this sector. In the absence of this it might be a very long while till true value is reflected in the share price

6th Mar '20

Hi Jock,

Fair point - I suppose you could argue that specialising in taking over and extending the lives of mature O&G assets is environmentally friendly in some sense, given that the infrastructure has already been built & should therefore be maximised and then safely decommissioned?

Re. institutional interest - ESG considerations might put some people off but if others see a mispricing opportunity at such low valuations, I reckon it can attract enough interest to move #RRE share price given how small the company is on a market cap basis.

And if not, if the group's assets can meet production forecasts, the resulting profits, cash flow, dividend payments and/or acquisitions could be enough to lift the share price regardless of ESG sentiment.

gregatr0n

Really good article Jack. I've had Rockrose Energy (LON:RRE) on my research list for a while now, but somehow it always got bumped for another stock. You've managed to get me re-enthused on it especially with the covid-19 sell-off taking it down another 6% today (1,314p at time of writing).

MichaelFBS

This is a great and very balanced piece and gives food for thought. Would I still buy at this level. Yes I intend to if I can find the time this afternoon 6/3.

I am not perturbed by the pension. Yes it is a large fund but these deficits/surpluses are calculated using current bond rates, when the liabilities are going to become due 10, 20, 30, 40 years from now. Nobody knows what the bond rates will be then. Today’s bond prices introduce a level of caution into pension valuations which is not reasonable of prudent IMO.

With regard to

“I do wonder why the company does not buy back any of its own shares at these levels, though...”

As I understand it, it would mean Andrew Austin being obliged to bid for the company as his stake would go above 30%. He of course could sell some of his holding back to the company or in the market to keep his stake below 30%:

“When a person or group acquires interests in shares carrying 30% or more of the voting rights of a company, they must make a cash offer to all other shareholders at the highest price paid in the 12 months before the offer was announced (30% of the voting rights of a company is treated by the Code as the level at which effective control is obtained).”

http://www.thetakeoverpanel.org.uk/the-code/download-code

This may be semantics but is the key word here not “acquires”?

However I am perplexed by this as there are many companies on the exchange where a person or group controls more than 30% of the stock.

Perhaps somebody cleverer than me can explain?

Regards

Michael

willhampson

Hi Michael, the Takeover Code has a procedure for a "Whitewash" whereby shareholders can waive the obligation for a shareholder going over the 30% threshold from being required to make an offer. I don't know the rules about links on Stockopedia, but if you google whitewash and takeover code you'll find lots of commentary on this. All the best, Will

Wilbraham

Why would one sweep the pension liability under the carpet when it's c. £400m against a market cap of £185m? I haven't studied the update and earlier reports but Jack's piece suggests they are quite serious about off-loading the pension liability in the near future.

My knowledge is very rusty now, but it used to be the case that a buy-out would be priced on something like gilts-0.25% while an IAS19 liability would be more like gilts+0.75% (as a proxy for AA corporates). So with a mean liability term of say 18 years that's a near 20% increase in liabilities to achieve buy-out. Plus likely some increase for more prudent longevity assumptions, strange pension increase terms and other margins. These are purely hypothetical figures to indicate potential scale of the uplift - for all I know it might be a US scheme of Marathon, though I'd wager it's for the UK employees. Also the scale of the buy-out deficit will depend a lot on how well-matched (or otherwise) their investment strategy has been since 31.12.18.

Rockrose revisited at 1.5 times forecast earnings

A step up in profitability... and uncertainty?

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Jack Brumby

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