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UNO Template 08 May 2013 Asia Pacific/Japan Equity Research Oil & Gas Exploration & Production Japan Petroleum Exploration (1662 / 1662 JP) Rating OUTPERFORM* INITIATION Price (07 May 13, ¥) 3,890 Target price (¥) 5,000¹ Chg to TP (%) 28.5 Resurgent reserves Market cap. (¥ bn) 222.32 (US$ 2.24) ■ Initiating at OUTPERFORM with ¥5,000 target price (potential return Enterprise value (¥ bn) 226.38 Number of shares (mn) 57.15 28.5%): Japan Petroleum Exploration (Japex) is undervalued on various Free float (%) 45.0 fundamental metrics, and we believe the market is overlooking its international 52-week price range 4,175 - 2,755 production growth and strategy. We calculate that the booking of the oil sands *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. expansion at Hangingstone (Canada) this year will cut the company’s ¹Target price is for 12 months. EV/proved reserve to $8/boe—half the global average and second-lowest Research Analysts among global peers, behind only Inpex (1605, OUTPERFORM, ¥690,000). David Hewitt ■ Stand-out reserves bookings ahead: A near-term catalyst could be the 65 6212 3064 [email protected] booking of the Hangingstone project, which is expected to be confirmed in the Horace Tse FY3/13 annual report in August and which we estimate will increase proved 852 2101 7379 reserves 17% that fiscal year—more than making up for the weak domestic [email protected] growth and the reserves reversal expected from the Hokkaido field. This would be by far the largest booking in Japex’s recent history. The Garraf oil project in Iraq in FY3/14 would add another 15% to proved reserves, though this would be only marginally accretive to earnings, in our view. ■ Connecting the dots, up, down and across: We also view positively Japex’s announcement in March to farm-in to an upstream Canadian LNG project (Montney), as this secures supply across the Pacific and is a link to the company’s downstream plans to build an LNG re-gas facility in Fukushima. The main overhang/risk for the stock is funding for these projects which, we argue later in the report, is manageable. ■ Valuation: We use a DCF-based sum-of-the-parts valuation to arrive at our ¥5,000 TP. We use conservative assumptions for the production of remaining domestic reserves (5% decline), account for potential deferred-tax liabilities, and apply a 20% NPV discount to reflect domestic production challenges. Share price performance Financial and valuation metrics Year 3/12A 3/13E 3/14E 3/15E Price (LHS) Rebased Rel (RHS) Revenue (¥ mn) 230,638.0 213,154.0 257,624.9 268,937.6 6000 120 5000 100 Operating profit (¥ mn) 15,048.0 11,455.0 17,487.3 14,507.3 4000 3000 80 Net income (¥ mn) 17,029.0 -6,660.6 16,171.0 14,160.3 2000 60 EPS (¥) 297.7 -116.4 282.7 247.6 Change from previous EPS (%) n.a. n.m IBES Consensus EPS (¥) n.a. -131.5 288.2 290.4 The price relative chart measures performance against the EPS growth (%) 70.1 n.m. n.m. -12.4 TOPIX which closed at 1188.57 on 07/05/13 P/E (x) 12.9 -33.4 13.8 15.7 On 07/05/13 the spot exchange rate was ¥99.33/US$1 Dividend yield (%) — — — — EV/EBITDA(x) 9.5 12.1 9.5 11.3 Performance Over 1M 3M 12M P/B (x) 0.71 0.74 0.70 0.67 Absolute (%) 10.2 15.3 13.6 ROE(%) 5.7 -2.2 5.2 4.4 Relative (%) -1.3 -7.4 -40.4 Net debt/equity (%) net cash 1.3 7.5 21.4 Source: Company data, Thomson Reuters, Credit Suisse estimates. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 08 May 2013 Table of contents Focus charts 3 Resurgent reserves 4 Production: Domestic doldrums, international growth 4 Reserves: Good news brewing 4 Strategy: Killing two birds with one stone? 4 Valuation: Cheap on any valuation metrics 4 Summary financials 5 Production: Domestic doldrums, international growth 6 Reserves: Good news brewing 9 Strategy: Killing two birds with one stone? 10 Company and industry overview 17 Valuation: Materially mis-priced 19 HOLT analysis 23 Company financials 24 Japan Petroleum Exploration (1662 / 1662 JP) 2 08 May 2013 Focus charts Figure 1: Japex – Consolidated & Consolidated + equity Figure 2: Japex – possible proved reserves bookings production growth 35% 350(mm boe) 30% 300 25% 250 20% 200 15% 150 10% 100 5% 0% 50 -5% - -10% Iraq? FY12 FY11 FY13 FY14 -15% Production Production FY14E FY15E FY16E FY17E Production Hanginigstone Consolidated growth Consolidated + Kangean / Sak I reversal Hokkaido standard Evaluation Source: Credit Suisse estimates Source: Credit Suisse estimates Figure 3: Credit Suisse forecast production vs. medium Figure 4: Japex – domestic gas production (Credit Suisse term FY3/16 target forecast) vs. domestic gas sales aspiration (kboe/d) (mn m3) 80 2,500 70 2,000 60 50 1,500 40 30 1,000 20 500 10 - - FY14E FY15E FY16E FY17E FY09 FY10 FY11 FY12 FY13E FY14E FY15E FY16E FY17E CS forecast Japex - Medium-term plan Domestic gas production Domestic sales aspiration Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Figure 5: EV / proved reserves– Japex vs. peers Figure 6: Premium (discount) to NAV – Japex vs. peers (US$/boe) 5% 25 22.5 23.0 23.5 23.6 20.7 0% 20 Average EV/boe = $15.9 14.2 14.6 -5% 15 12.5 9.3 9.8 10.1 -10% 10 8.0 6.6 -15% 5 -20% - -25% BG Inpex Japex Statoil Santos -30% PTTEP Apache Conoco CNOOC Talisman Anadarko Woodside -35% -40% Hokkaido -45% Santos PTTEP Woodside Oil Search CNOOC Inpex Japex Japex - adj for Hangingstone & Hangingstone for - adj Japex Source: Bloomberg, Credit Suisse estimates Source: Credit Suisse estimates Japan Petroleum Exploration (1662 / 1662 JP) 3 08 May 2013 Resurgent reserves Production: Domestic doldrums, international growth In the near term two major projects are driving production growth: the Garraf oil project in Iraq and gas projects in Indonesia: namely, North Sumatra Block A (FY3/15) and expansion at the Kangean PSC (recorded as an equity affiliate). Given low expectations regarding domestic oil or gas production growth, the net effect will likely be a reduction in normalized gross profit / boe. Reserves: Good news brewing Despite a likely reserves reversal from the Hokkaido field this year, the effect of booking the Hangingstone oil sands (Canada) expansion in FY3/13 should leave total proved reserves up 17%, and if Iraq’s Garraf reserves can be booked in FY3/14 it would increase reserves a further 15%. The FY3/12 annual report comments that there is a disparity in the reserve forecast between some of the external auditors and Japex; we hope to get some clarity in the FY3/13 annual report due in late summer. As long as no major reversals result from the review, the ability to book two material reserves additions should be positive, although the Iraq reserves are of low value per barrel given the fiscal terms in that country. Strategy: Killing two birds with one stone? In its medium-term plan, Japex calls for both an increase in overseas production and to support its domestic gas business. This is why we view positively its announcement in March to farm-in to a shale-gas-to-LNG project in Canada (Montney, British Colombia) as it would have an upstream project which would connect to its planned LNG re-gas facility in Fukushima. If it sanctions its proposed LNG re-gas facility in Fukushima and concludes the deal with Petronas in Canada (and if that project then takes sanction) then the capex burden would be >50% on a net D/E basis. However the Canadian LNG project may look for project financing, and Japex has the added firepower of selling long-held investment securities to manage its balance sheet. Valuation: Cheap on many valuation metrics Viewed against a range of fundamental valuation metrics, Japex appears materially mispriced. Proved reserves / boe is very low, at US$10 / boe, and is poised to go lower as the company books the oil sands expansion. Our DCF-based SoTP, which uses conservative assumptions for the production of its remaining domestic reserves, takes account of the potential deferred tax liability and then applies a 20% NPV discount, still leaves us at ¥5,000 / share. The reserve booking should provide a catalyst, the major risk is long-dated funding (if all projects under consideration go forward). Japan Petroleum Exploration (1662 / 1662 JP) 4 08 May 2013 Summary financials Figure 7: Japex – key assumptions & financials Year-end 31 March FY11 FY12 FY13E FY14E FY15E FY16E FY17E ¥/US$ 79.8 79.8 81.0 95.0 95.0 95.0 95.0 Brent – US$/bbl 86.7 114.4 109.7 116.3 103.8 95.0 96.9 Production Total O&G prod’n – consolidated 38.6 38.2 33.4 32.7 42.4 38.3 43.7 YoY growth – consolidated -2% -1% -13% -2% 30% -10% 14% Total O&G prod’n – consol+equity 45.2 48.3 58.7 52.9 58.5 YoY growth – consol + equity - - - 7% 22% -10% 11% Realised prices Natural gas – US$/mmbtu 17.6 19.4 19.7 20.7 18.5 16.9 17.3 Correlation to Brent (%) 114% 95% 101% 100% 100% 100% 100% LNG – US$/mmbtu 17.1 18.7 18.9 20.7 18.5 16.9 17.3 Correlation to Brent (%) 110% 92% 97% 100% 100% 100% 100% Domestic production 93.8 114.4 116.1 121.7 108.6 99.5 101.5 Income statement (¥ mn) Net sales 199,651 230,638 213,154 257,625
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