AKAAF - Aker BP: Operationally Phenomenal But Relevant Interest Creep

2023-07-17 02:01:40 ET

Summary

• Aker BP is doing phenomenally on every metric; production, operating profitability, and new discoveries.
• We expect these conditions to last as well due to structural factors around the oil supply and Saudi policy.
• However, there is interest creep, and it is understated because some interest gets capitalised. Considering that it could be cheaper.
• At least its debt is in USD. They're not exposed to the possible belated BoN rate hiking cycle.

Aker BP ( AKRBF ) is a great E&P company from Norway part of the Aker ASA ( AKAAF ) umbrella. They are making new discoveries, and production ramp-ups in their fields have rocketed their production, revenues, and operating profits. Things look great, but interest creep has hurt them, and it is being understated in EPS due to the substantial capitalising of interest costs inherent to the accounting of these project-based businesses. Luckily, they are not exposed to the emerging rate cycle in Norway, but we still think anything can happen as far as US rates go, as well as the demand drives for oil. Structural factors remain though which are constructive to the oil price.

Quarterly Review

The latest quarter was Q2 , and we'll bullet point the key takeaways.

The Good

• Since our last coverage of Aker BP, the company has delivered on its phase II production drive across several fields, notably on Johan Svedrup. Production has more than doubled and continues to creep up. Utilisation is extraordinarily high as Norway has become one of the primary partners to Europe in terms of oil production.
• They have also made a relevant new discovery which is equivalent to about 50% of Aker BP's annual production but in terms of gross volume. We don't know how quickly that volume can be pumped, so the likely increase to production will be a lot less. Compared to Johan Svedrup, it seems that this has about 3% of the total expected reserves. But importantly, Aker BP's ownership and interest in these projects is higher than Johan Svedrup, which was a massive project and shared by several E&P players. No production till 2027.
• Operating profit has improved in line with sales growth, and unit costs have dramatically reduced. Since the ramp up production costs per barrel have been reduced by almost 50%. EBITDA has almost doubled .

The Bad

• The interest expense has come up meaningfully. Most of the debt is USD denominated and beholden to US interest cycles. Aker BP repurchased bonds for a one-off gain that reduced the burden in Q2, but run-rate is being affected by the higher US interest rates. While CPI and jobs data spell hopes for a soft landing, we assume that rates will continue to rise till there is a recession. Interest expense is up around 66% because they repurchased bonds and actually grew net debt at higher average interest rates to finance new projects.
• To continue on the interest issue, very substantial amounts of interest expenses get capitalised due to accounting standards around project-oriented businesses. The true cost of higher rates is greater impairment risk due to inflated asset balances on the fixed asset side, as well as weaker ROAs. Interest expenses would be more than 50% higher if it weren't for capitalising interest.

Bottom Line

The company is not that cheap either. It trades around the 9-10x PE range. The rates in the US may not go much higher than where they are now, while the Bank of Norway is only getting started with probable rate hikes due to higher relative inflation and a very slow policy response leading to a weaker NOK. It's good news then that Aker BP's bonds are not NOK denominated.

There is also risks that interest rates may go even higher in the US. Luckily, the maturity profile means Aker BP won't be refinancing at higher rates, and its debt is fixed, but it could lead to a demand side problem if the last leg of inflation needs to be tripped by a recession in the US. That could lead to some meaningful demand pressure on oil prices, where supply is structurally favourable to the oil price due to Saudi and OPEC consistency in keeping supply limited, as well as intermediation pressures happening as Russian oil takes the scenic routes to make international rounds.

Still, not a screaming buy, possibly just a decent one on the production excellence and strategic positioning in Europe - as well as the beaten-down price.

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