M&A to be a key driver for the E&Ps; Tullow & Africa Oil up to Buy
* We continue to believe M&A will be a key theme in the E&P space
We continue to believe that M&A will be a key driver for the industry, and more specifically for the E&Ps, as highlighted in our report of February 24, 2015, “Scaling up production and FCF yield; reiterate CL-Buy on Dragon
Oil”. We expect well-funded majors and NOCs to scrap high-cost, highcomplexity projects and focus on gaining exposure to low-cost projects via M&A. We see potential for 5-10mnbls/d of low-cost projects to move from
E&Ps/independents to majors/NOCs, substituting less attractive developments. We upgrade Tullow Oil and Africa Oil to Buy from Neutral, believing that both offer exposure to strategic assets which sit low on the cost curve. We also flag Buy-rated Genel and Dragon Oil, which screen well on an M&A basis
* Tullow up to Buy; diversified and strategic portfolio
We upgrade Tullow to Buy from Neutral with an updated 12-month price target price of 411p (from 416p), implying 21% upside. We believe the stock offers exposure to a strategic asset base, given its materiality, oilphase
and positioning towards the bottom of the cost curve in Western and Eastern Africa. In our view, Tullow’s full-cycle portfolio offers diversification and a cash flow uplift driven by the TEN developments in Ghana (due on-stream in mid-2016); on our estimates, Tullow will turn FCF positive from 2017. We continue to believe Tullow is fully funded for this development, particularly given its successful credit facilities renegotiation.
* Africa Oil up to Buy; Lokichar basin exposure in Kenya
We upgrade Africa Oil to Buy from Neutral with an updated 12-month price target of Skr17.2 (from Skr18.40) implying 18% upside. We believe the stock offers exposure to a strategic asset (Lokichar basin) given its onshore
location, oil phase and positioning at the bottom of the cost curve; on our estimates the Lokichar basin breaks even at c.US$27/bl. We believe Africa Oil screens as an attractive M&A target (see, “Scaling up production and
FCF yield; reiterate CL-Buy on Dragon Oil” for details of our M&A framework) at the corporate/asset or farm down level given the industrywide focus on lower cost curve. Being conservative, we assume a CGT rate of 37.5%, payable by Africa Oil on its Kenyan assets, within our M&A valuation of the stock. We would expect any reduction in this tax rate to be taken positively as it would increase the likelihood of M&A in our opinion.