JKX Oil & Gas (JKX) – Oligarchs offer investors a growing recovery play

JKX Oil & Gas (JKX) – Oligarchs offer investors a growing recovery play

JKX Oil & Gas (JKX) is a Russia/Ukraine focused company which is well positioned to benefit from booming natural gas prices.

The company has had historic issues with major shareholders battling over the company’s direction. Additionally, previous management had an awful track record when it came to capex and investments. New management has come in with an improved strategy focused on work overs and initiatives which have a high chance of success and contributing directly to the bottom line.

Production in H1 was 8,728 boepd equivalent (approximately 90% of which is gas production) which for a company with a circa £50m market cap is compelling. The company showed a modest profit before exceptional items of $7.4m and $1.9m after them. The company worked over a number of wells during the first half which should further increase profitability.

Of note is the increase in gas prices this quarter as evidenced by the first six month chart followed by July to date:

(Source: Ukrainian Energy Exchange)

Extrapolating the increase in gas prices yields an average increase for the quarter so far of approximately 10%. Assuming no increase of production (which there is) and no reduction in costs (unlikely), profitability should increase substantially.

Given the increase in gas prices (and assuming they remain elevated), then H2 revenues could increase to approx $46.6m (compared to H1 revenues of $42.4m).

Stripping out exceptional items the company generated a profit of $7.4m which calculating backwards means that the company could approximately generate $11m for the second half. If the company continues that going forward we’d be looking at about $22m of profit per year (about £17m) putting JKX on a P/E of approximately 3.

Risks – tax cases and oligarchs

It is worth highlighting that the company has some historic tax cases against it which have been ongoing for years; the company does have provisions in its balance sheet ($43m worth) for them and the cases are continually delayed for ‘evidence’, whatever that means. As an aside the Ukrainian government’s track record regarding JKX is not particularly impressive. They lost a UK court case against JKX as per the following RNS and were ordered to pay JKX $12m, see here.

Given the provisions on the balance sheet the market may be overestimating the risk from these cases: if they lose they pay cash they have provisions for, and if they win then a lot of the restricted cash will become unrestricted.

The shareholder register may raise eyebrows as Ukrainian oligarchs (or their vehicles) own a significant percentage of the company. The free float is also low with only 22% of the shares in public hands. Recently a Ukrainian MP and oligarch bought 20% from an activist fund. A risk from my perspective would be that they may attempt to take the company private should the share price languish.

Additional upside

Perhaps more positively the oligarchs and JKX, via a 10% stake, are also involved with Ukrnaftoburinnya ‘UNB’ which is growing quickly. Net profits at UNB increased from UAH 1.1bln (~£30m) in 2016 to UAH 1.95bln (~£50m) in 2017. Were UNB interested in floating they may consider an RTO of JKX which could materially re-rate the share price.

Given the company’s development plans and large 2p reserves (95.1 million boe), JKX is potentially very cheap, particularly given that it has the reserves to increase production.

The company is also working hard to reduce overheads. An example of the changes made to the structure of the company was highlighted in the half year report which states “A new scheme of staff motivation has been implemented, based on specific KPIs for each department.”.

In conclusion at circa 30p JKX is an interesting oil and gas play given the potential free cash flow, possibility of increased gas production and cost savings as the company reduces its overheads. The Q3 results due should make for particularly interesting reading.

 

Disclosure: at the time of publication, the author holds a long position in JKX.

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