updated valuation

as 24th Jan

aluation: $1.07Last updated:24/01/11
Pike River Coal disaster increases risk

Investment rating

NZO is an oil and gas explorer and producer with minority stakes in two producing oil and gas fields in New Zealand. Investment in Pike River Coal?s equity and debt was worth around NZ$170m before the tragic explosion killed 29 miners but we expect little if any value to be recovered. Market capitalisation is now similar to peers TAP Oil and ROC Oil. Value now resides in its producing oil and gas assets as well as exploration potential. Despite a good dividend yield, oil price exposure and exploration uncertainty make the shares suitable only for high risk tolerant investors.

Event

NZO?s share price has fallen 32% since the tragic Pike River Coal (PRC) mine disaster.

It had around NZ$170m invested in PRC?s debt and equity but insurance payouts may salvage only some of the NZ$65m debt. PRC?s equity is worthless.

Impact

The loss of its coal assets makes NZO less diversified and more risky. Fewer producing assets also increases proportional exposure to risky exploration activities.

A 5.8% dividend yield attracts but we caution against investment for the dividend alone. This stock has high capital risk with an increasing dependence on exploration success.

Recommendation impact (last updated: 24/01/2011)

Despite the risks, the share price fall appears overdone. At NZ$0.86 a share our NZ$1.07 fair value implies an Accumulate recommendation.

Event analysis

NZO?s share price has fallen 32% since the tragic Pike River Coal (PRC) mine disaster. Market capitalisation has lost A$170m or roughly the value of its combined equity and debt investment in PRC. We agree with the markets assessment. PRC entered receivership last month, NZO?s NZ$105m equity investment is now worthless. Insurance payouts may salvage some of the NZ$65m debt but we hold out little hope. Receiver?s fees will be paid first. NZO?s value now resides in its oil and gas assets. Proportional exposure to exploration activities has increased as has risk.

NZO has exposure to two offshore oil and gas fields located within 50km of the west coast of New Zealand. They comprise minority stakes in the Tui and Kupe fields with 2P reserves of 2.6mboe and 9.8mboe respectively. Both fields suffer from natural production decline, the impact on revenue is shown in our chart below. Expansion beyond New Zealand is planned with exploration and development opportunities investigated globally.

We value the Tui and Kupe stakes at NZ$100m and NZ$237m respectively. Long term assumptions include: US$80/bbl oil; NZ$7.8/GJ sales gas; NZ$1,000/t LPG; and an NZ$/US$ exchange rate of 0.60. We value the PRC debt at NZ$13m. Other assets include net cash of NZ$85m and Pan Pacific Petroleum shares worth NZ$20m. Total identifiable assets of NZ$455m are largely offset by future exploration spending and corporate costs of NZ$250m.

All four exploration wells drilled last year were unsuccessful but future exploration, funded for around 10 years, provides ample opportunity. The current market capitalisation implies around NZ$133m for the exploration assets. We consider this conservative based on previous success with Tui and Kupe and value exploration potential at NZ$200m. Upside could also come from increases to existing reserves. Tui?s 2P reserves have increased 80% (2.8mboe) since production began in 2006. ?Blue sky? resides in higher than expected PRC debt recovery, stronger than expected commodity prices or a larger than expected oil and gas find - over 5mboe.

Oil and gas exploration and production is an expensive business with success increasingly rare. Costs and risks have risen as exploration locations become more remote. Shares in peers ROC Oil and TAP Oil trade below 2001 levels, AWE and NZO are back to 2005 levels. The volatile oil price adds further uncertainty.

Over the past five years, NZO generated around NZ$300m from operations but spent NZ$500m on exploration and development. Investment spend should fall significantly now Kupe is operational but production declines will weigh on cash flows. Market capitalisation has fallen to NZ$333m following the disaster, similar to peers TAP Oil and ROC Oil. A 5.8% dividend yield attracts but we caution against investment for the dividend alone. This stock has high capital risk with an increasing dependence on exploration success. Despite the risks, the share price fall appears overdone. At NZ$0.86 a share our NZ$1.07 fair value implies an Accumulate recommendation.