23 April 2014 OIL & GAS Initiation of Coverage Marketing Communication (Connected Research) Madagascar Oil# BBG Ticker: MOIL LN Price: 16.25p Mkt Cap: £86.4m BUY Year to Revenue EBITDA PBT EPS EV/Sales EV/EBITDA P/E December (US$m) (US$m) (US$m) (US$¢) (x) (x) (x) 2012A 0 (13.6) (13.6) (5.5) n/m n/m n/m 2013E 0 (10.3) (10.4) (2.0) n/m n/m n/m 2014E 0 (11.0) (11.1) (1.0) n/m n/m n/m 2015E 108.6 87.4 87.6 6.0 1.0 1.3 4.3 NOTE: US$/£ forward exchange rate = US$1.60. SOURCE: Company, VSA Capital estimates. Approaching Delivery Giant Tsimiroro Field Close to Commerciality Company Description Madagascar Oil is an E&P company with Madagascar Oil (MOIL) is the largest acreage holder onshore Madagascar, undeveloped assets onshore Madagascar. with interests in five blocks covering approximately 30,000km2. The One Year Price Performance Tsimiroro field is by far the most important asset owned by the company. It (m sh) Volume (LHS) (p) 40 20 was discovered in 1909, but remained undeveloped, largely due to political Price (RHS) 35 instability in the country, low oil prices and lack of infrastructure. This 30 15 onshore low sulphur heavy oil field, located at a very shallow depth of 25 between 100 and 200 metres below ground, is estimated to contain a 20 10 massive 1.7bnboe of 2C contingent resources. To confirm the commercial 15 potential of this resource, MOIL started its Steam Flood Pilot project in April 10 5 5 2013. A year after the project was launched, oil production was in excess of 0 0 60kboe for the period and results have been conclusive with regard to the 04/13 07/13 10/13 01/14 04/14 reservoir response to the thermal recovery technique. We expect MOIL’s Price % chg 1mn 3mn 12mn Board to declare commerciality and launch the development phase on this -5.1% 15.0% 20.4% vast oil field before the year end. 12mn high/low: 18.0p/8.68p SOURCE: FactSet, as of 22 April 2014 close. Next Year Will be a Turning Point Market: LSE AIM Price target: 70p After several years of political turmoil, Madagascar has now regained Shares in issue: 531.5m credibility with international institutions through its newly-elected President Free float: 24% and his government. This should help rebuild confidence among investors Net cash (Dec 2013E): US$26.7m and bring long-awaited stability to the country, creating a solid basis on Enterprise value: US$111.5m which companies can rely to develop their projects. MOIL will soon be able Next news: Commerciality/H2 2014 to start its first phase of development. This three to four-year phase targets Major shareholders Benchmark 39.0% first oil in 2015, with a quick ramp-up to reach a 10kboe/d plateau by 2017. SEP African Ventures 20.1% The capital expenditure required to build the entire project infrastructure Outrider Management 21.9% will be significant, but 2015 will see the first real production, making MOIL profitable for the first time. We think investors should be encouraged by the Marc Anis-Hanna, Oil & Gas Analyst operational progress as the field development moves forward. +44 (0)20 3617 5182 | [email protected] Edward Vaughan, Recommendation and Target Price Geologist/Assistant Analyst We initiate coverage on Madagascar Oil with a BUY rating and a 70p target Edward Hugo, Head of Research price, in line with our risked NAV using 11% WACC and US$100/boe flat +44 (0)20 3617 5187 | [email protected] long-term oil price. #VSA Capital acts as Corporate Adviser to Madagascar Oil. This research brochure is a MARKETING COMMUNICATION. It is not investment research and has not been prepared in accordance with legal requirements designed to promote investment research independence and is also not subject to any prohibition on dealing ahead of dissemination of investment research. Investment Summary Strong Potential for Growth Madagascar Oil (MOIL) offers investors access to a largely underestimated onshore oil project that has attractive long-term economics. Over the next 20 years, rapid production growth will be delivered through the development of MOIL’s main asset, the giant Tsimiroro heavy oil field. This already-established resource, located at a very shallow depth of between 100 and 200 metres below ground, was discovered 100 years ago and is estimated to hold significant 2C contingent resources of 1.7bnboe. After several delays, largely due to political instability and low oil prices, the company recently commenced its proof-of-concept Steam Flood Pilot which will continue to operate throughout 2014. During this appraisal phase, more clarity has been provided regarding the reservoir quality and the ultimate recovery rates. In our view, this will lead the company to declare commerciality on the Tsimiroro field before the year end. Risked NAV breakdown (US$m) Production Profile (kboe/d) Exploration Financing NAV, 2% NAV, 12% 100 Phase 1 - Risked 80 NAV, 5% 60 40 20 Contingent NAV, 81% 0 2015E 2019E 2023E 2027E 2031E 2035E 2039E 2043E SOURCE: VSA Capital estimates. SOURCE: VSA Capital estimates. Following the declaration of commerciality, MOIL will then proceed with a full field development plan, in order to launch Tsimiroro Phase 1 development, primarily targeting production of 10-20mboe of this heavy low-wax crude oil. First oil is expected in 2015 and should quickly ramp up to plateau at 10kboe/d. In the same year, initial cash flow will enable the company to support the funding of part of the capital spending required to build infrastructure for the subsequent phases, which will start in 2018-19, and build towards plateau production of 100kboe/d from the field over a number of years. In our view, this will make MOIL an extremely interesting growth story. Some Challenges Remain Questions remain regarding MOIL’s ability to reinforce its management team, having not had a CEO since July 2013. Although the company is effectively run, and major milestones have been validated, future steps will require a new CEO to be hired, either externally or sourced in-house. The second challenge concerns high initial capital costs. Madagascar is an undeveloped country and lacks infrastructure. Operating in this environment could easily become difficult for oil companies, especially with the region’s tropical weather. MOIL will have to invest in road upgrades, a new pipeline and onsite constructions. (See Appendix 1: Madagascar Overview.) Nevertheless, we think there is deep value in the project which is not currently factored into MOIL’s share price. The company is now ready to take a major step towards rapid production growth and to increase shareholder value. The initial cash inflows will also allow it to start exploring its three other blocks, potentially scaling up its asset base in the case of successful campaigns. - 2 - Valuation Value creation in the E&P industry follows a number of different stages: exploration, appraisal, development and eventually production. MOIL has completed the exploration stage with the Tsimiroro discovery, which has a massive resource estimate of 1.7bnboe. The Steam Flood Pilot (SFP) appraisal phase, launched by the company a year ago has proved the recovery potential of the source and the Board should now confirm commerciality of the project and submit a full field development plan (FDP) by the end of 2014. The company will then enter into the more capital intense development phase. MOIL will have to support capital spending for the upgrade of existing roads from the field operation to the capital, Antananarivo, in order to allow transportation of its oil via trucks. The company will also need to upgrade parts of its facility in order to increase the overall production capacity. We estimate the capex required for Phase 1 to be between US$200m and US$400m. We think the quickest route for MOIL to be rerated is to Required Funding (US$m) complete its initial Phase 1 development and de-risk the rest of its asset while ramping up production through 180 the following phases, and eventually delivering a strong 160 stream of cash flows. On our estimates, production 140 during Phase 1 should reach 10kboe/d, allowing cash US$150m required 120 funding for the from operations to exceed US$100m/year from 2016E. next 2 years. 100 However, because MOIL will be loss-making until 2015E 80 and is not currently generating cash, it will require 60 funding over a number of years to fulfil its future 40 development capital spending. For our NAV calculation, we use an estimate funding requirement of ~US$150m. 20 0 As MOIL is still a small company, and therefore, -20 accessing the debt market is not straightforward, the 2009 2010 2011 2012 2013e 2014e 2015e company is currently debt free. We believe it has two Total Sources of Funds Total Uses of Funds main options to fund itself: either by reducing its stake in the project or through an equity raise. SOURCE: VSA Capital estimates. Farm-Out MOIL is currently undertaking a farm-out campaign on its exploration assets in licences 3105/3106/3107. As the number of wells drilled to date is very low and there is not yet sufficient data, we have decided to allocate a very low chance of success to the exploration and development of these assets, reducing their NAV. In our view, farm-out of the exploration blocks would not be enough to raise adequate funding, and we believe that MOIL may have to reduce its stake in its main Tsimiroro asset.