Last week FNArena highlighted Karoon Gas ((KAR)) given upside potential from extensive drilling programs in both Australia and South America (see: Karoon Offers Cause For Optimism) and this week broker coverage of the company has increased.
Deutsche Bank has initiated on Karoon with a Buy rating and $9.00 price target, which is above the consensus price target according to the FNArena database of $8.28. As with others in the market, the attraction for Deutsche is the upside potential from Karoon’s exploration program.
In Deutsche’s view Karoon’s leverage to exploration is unparalleled among Australian stocks under coverage, as the group’s acreage footprint is in leading basins and has been de-risked by extensive technical work.
The Santos Basin in Brazil will be the key driver in 2012 according to Deutsche, as a farm-down of Karoon’s interest is expected by the end of the second quarter of this year. A farm-in by a major player could boost confidence in the potential of the block and spur a re-rating ahead of a three well exploration program due to start in the third quarter of this year.
The risk/reward proposition for the Santos Basin is attractive in Deutsche’s view, as a 200 million barrel discovery could be worth as much as $5.40 per share on the broker’s numbers. Any discoveries from the upcoming exploration program are likely to be followed by extensive flow testing, with potential for full development from around 2014-2015 and first commercial production from 2016-2017.
Karoon also holds a 40% stake in the Poseidon Fields in the Browse Basin in offshore Western Australia, which Deutsche sees as a longer-dated project. Further de-risking is required, so a 5-8 well program set to begin this month will be crucial in delineating the size of the resource and assessing reservoir quality in Deutsche’s view.
In 2013 exploration will commence in the Tumbes Basin in Peru, where Deutsche notes Karoon has 16 identified leads and prospects with a mean prospective resource of 2,385 million barrels. A farm-in partner for the Tumbes Basin could also be secured this year, which would provide funding for Karoon’s share of planned exploration.
Exploration costs money but here the outlook for Karoon is solid in Deutsche’s view, as the broker notes the company had retained cash of $267 million as at the end of last December. A further $40 million in security deposits is to be released this year.
Deutsche sees this as leaving Karoon well positioned to fund the upcoming Poseidon appraisal program, while a farm-down of its stake in the Santos Basin is expected to leave Karoon with around $150 million surplus funding capacity.
If Karoon cannot complete a farm-down of its interest in the Santos Basin in the June quarter the available cash balance should be enough to fund the initial two wells of the program. Deutsche estimates the complete three well program will require capex of around US$240 million.
Exploration success will be the main driver of the Karoon share price for some time, as Deutsche doesn’t anticipate the company becoming an earnings story until large scale production commences. This is likely to be in 2016 at the earliest.
Factoring in exploration success rates in line with global exploration success rates, Deutsche values Karoon at $9.25 on a net asset value basis and sets its price target at a slight discount to this level. With Deutsche adding a Buy rating, the FNArena database shows Karoon now scores a perfect five-for-five Buy ratings.
Shares in Karoon closed yesterday at $5.90, which compares to a range over the past year of $2.60 to $7.54. Yesterday’s closing share price implies upside of better than 40% relative to the consensus price target in the FNArena database.