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SDX SDX Energy


Current SP 51p

14/01/2017

Target 110p


Shares in Issue: 204,459,708

Market Cap: £104m


Producing 3800 BOED

Current underlying RENAV £163m

or 80p per share


Zero Debt

$52m Working Capital
of which $31m is CASH

Generating huge free cash:

$44m 2018

$54m 2019

Fully funded for significant expansion plans


Huge Q1 2018 Drill programme with 5 drills in Morocco and 4 drills in Egypt running in parallel with 2 drill rigs

 


Near term share price catalysts:

Major South Disouq 4 well, drill campaign commences mid-Jan targeting 100 MMscf/d
1st Well - ‘Ibn Yunus’ is targeting a VERY LARGE pre-identified pay zone
Total volume potential at South Disouq could exceed 2.5 TCF (unrisked)
Share price catalyst complete In parallel, the 9-well drill programme in Morocco continues – currently on well 5
Share price catalyst complete Results in 4 of 5 wells so far are well ahead of expectations and set to continue
Share price catalyst complete Brent prices at $70 have more than DOUBLED netbacks since $40 Brent
Annual reserves upgrade due end Q1 2018
Q4 and 2017 Annual results due end March

The Company

SDX Energy, AIM: SDX an Egypt and Moroccan focused Exploration & Production business with high margin production and huge transformational exploration upside with significant near term activity and news flow.

It’s cash rich with Zero debt, 3800 BOED current production, $52m of working capital which includes $37m cash, its predicted to generate free cash of $44m in 2018 and $54m in 2019  which is very rare for an AIM oiler. The company is highly attractive as it trades at nearly a 50% discount to its book value of 80p per share.


The Company possesses a number of exciting exploration assets in Egypt and Morocco:


  • SDX can generate positive cash flow down to US$10/bbl Brent (at Corporate level) - yes $10!! Importantly, that protects it from low oil prices whilst leaving it extremely well placed to benefit from any increase in the oil price

  • Management intend to build the company to produce in excess of 30,000 BOED. That would become a very material acquisition to a major player (CEO has openly stated £billion Market Cap Target). He’s a superb CEO, excellent communicator and strategic thinker - with a fantastic track record, having done it before with Pioneer see here)

  • There are a number of near term catalysts and sentiment driven news flow which will close the current discount to underlying NAV of 80p



The Company possesses a number of exciting exploration assets in Egypt and Morocco which are being developed in 2017:


  • South Disouq 1st exploration well ‘SD-1X’ was hugely successful in Q2 2017, resulting in a significant gas discovery. The well flowed at a restricted rate of 26mmscf/d. They also hit the deeper oil working system but failed to log it for risking the upper gas zone. This will be the subject of an additional drills in Q1 2018

  • 9 Well drill programme in Morocco kicked off mid September 2017. There are literally eye-watering margins in Morocco; low costs of US$1 per MCF are then sold on a contract at a price of US$10 per MCF (increasing to US$12 MCF in a planned 2017 re-contract). SDX plans a multi-well development program in Morocco in 2017 to massively ramp up production capitalising on those huge margins – the first three of four wells were gas discoveries well ahead of expectations. Now moving to well 5

 











The Investment Case

 OK, so let’s get into the meat and drink of this exciting company whilst keeping this as simple as possible. 

Firstly, a quick run-down on the assets:

 

EGYPT Producing Assets

 

North West Gemsa: (50% Working Interest) 

Sales volumes average 2538 bopd net to SDX Energy for the half year 2017. Importantly this is a big chunk of SDX current production and it will be maintained at these levels following a programme of workovers in 2018. 

From the company:

 

 

Meseda: (50% Working Interest) 

SDX Energy holds 19% ‘Net Revenue interest (NRI)’ in this block. 

Currently producing 3342bopd (during H1 2017) giving (SDX NRI production of 635bopd). SDX have recently uncovered a new Oil Discovery here called ‘Rabul’ and this will be the subject of further drilling in Q2 2018 (more to come on this later). 

 

From the company:

 

 

Morocco Producing Assets

 

Sebou concession: (75% Working Interest) 

Following the recent Acquisition from Circle Oil, SDX have acquired a 75 per cent interest in the Sebou concession which is producing around 6 MMscf/d gross that adds net production of approximately 4 MMscf/d (639 boepd) NET to SDX. 

As explained earlier, margins here are eye-watering, with gas being produced for $1/MCF and being sold for a whopping $10/MCF so throwing off huge free cash due to these margins. As if that wasn’t good enough, due to local gas demand outstripping supply, future gas price contacts are due to increase to $12/MCF based on a recent MOU signed. 

SDX have also acquired the pipeline from the basin to the sales point which will drive expansion because the pipeline is currently only transporting 6MMscf (1000boepd) with a maximum 24MMscf (4000boepd) so a huge opportunity to ramp up production from new development wells (see 2018 plans below). 

SDX also acquired new acreage in Morocco in Q2 2017, expanding the opportunity to maximise on those huge gas margins. The announcement can be found here.

 

From the company:

 

Total Current Producing Assets (confirmed for 6 months of 2017): 

North West Gemsa: 2538 BOPD

Meseda: 635 BOED

Morocco: 639 BOED 

Total SDX Energy: 3812 BOED 

 




Quarter 1 2018 Activity and near term Newsflow and SP catalysts

This is where it gets very interesting indeed. Here is an overview of the planned activity for Q1 2018 and as you can see there is loads going on which will drive significant growth of the company.

 

From the company:

 

 

Egypt & Morocco plans for Q1 2018

 

North West Gemsa: 

In 2018, SDX intends to maintain gross production at 4,422boed. (Net 2,211 to SDX) Work plans for 2018 include drilling 2 wells (AASE-25 and AASE-27) and undertake seven workovers.

 

Meseda: 

The 2018 plan is to increase gross production to 3,800bopd (722 net to SDX). SDX plans to drill four wells in 2018. Two wells to develop the Rabul discoveries (Rabul-3 and Rabul-4) and two wells to maintain production in the wider Meseda area (Infill Producer-1 and Infill Producer-2). The company also aims to replace up to five ESP’s in the wider Meseda area. 

 

South Disouq (55% Working Interest) 

The concession is located within the prolific Abu Madi – Baltim trend which to date consists of 10 discoveries containing 6.3 TCF of gas. 

5 drill locations in this licence area have been identified, the first “SD-1X” was drilled in Q2 which resulted in a significant gas discovery see here and it flowed at a massive 26mmscf/d which was restricted due to surface facilities see here. 

SD-1X Originally planned to target just the prolific gas zone but the 3D seismic identified potential oil bearing zones in the deeper oil horizons of Abu Roash & AEB which are prolific producers in the western desert. 

This new 3d seismic data has gathered a lot of interested from some big local oil majors in the area who are interested in farm in. Paul Welch has now stated that he doesn’t wish to farm in as they are in a solid financial position as it is – what a position to be in! 

SDX confirmed they hit the working petroleum system during the drilling of SD-1X but not sufficient hydrocarbons to justify completing that zone see here. This will be targeted in future drills in development wells. 

Following the Gas Discovery of SD-1X, SDX announced a revised resource update compiled by Gaffney, Cline & Associates (GCA). This was a significant update which x3 the company reserves with much more to follow as they develop South Disouq see here. 

SDX are now discussing an early production plan with the Egyptian authorities with the aim of bringing the production on-line end H1 2018. 

Whilst reviewing post-discovery technical work, management have identified two new prospects (in addition to the SD1-X and the two development wells) called the ‘Kelvin and Ibn Yunus prospects’. 

Management concluded that a South Disouq development plan should explore these prospects which they hope will prove up 150bscf of reserves and it could also confirm that Kelvin and the SD-1X zone are one large structure. This would be huge news for SDX and so management launched a fundraise of $10m to finance these additional drills which can be found here. Ibn Yunus structure also looks huge (see ‘section through inversion seismic’ slide below) and will be the first target to spud in January 2018. 

This new South Disouq development plan now consists of two SD1-X development wells plus two exploration wells at Kelvin & Ibn Yunus – so a 4 well campaign commencing early Q1 2018, with a spud date of the 1st well confirmed as January 2018. The final well ‘Kelvin’ will target the deeper oil zone once more

Clearly the South Disouq acreage has been de-risked and the CEO anticipates future wells coming on-line between 15-20 mmscf/d and so they are currently looking at larger facilities which could cope with production of up to 100 mmscf/d.

The company are confident of achieving approx. 50mmscf/d from three wells in the SD-1x structure (this would deliver approx. 4600BOED Net to SDX. Clearly, this leaves upside on the back of success at Kelvin and Ibn Yunus which is not included in this guidance.

The company states the total volume potential at South Disouq could exceed 2.5 TCF which is huge and company making on its own.

 

From the company:

Take a look at the structure above and the red colour is the Gas Sand. We can see the depth on the SD-1X well and where they hit the three pay sands. If you then look at Kelvin and in particular Ibn Yunus, you can see a larger pay sand target which if successful could be very significant indeed both for production and reserves. These prospects will all be drilled commencing January 2018. 

 

 

 

This is huge volume potential – 2.5 TCF (unrisked)

 



Morocco Drilling Programme – Q1 2018

 

Sebou concession: (75% Working Interest) 

Remember, this is where there is huge scope to increase production towards the 24MMscf/day pipeline capacity and SDX are not hanging around, drilling 9 (yes nine!) back-to-back wells; 7 x development wells and 2 x exploration wells commencing September 2017 for an investment of $23m which includes pro-rata connection costs to customers (so that’s the ‘all-in’ costs). 

These 9 wells are anticipated to grow sales to customers by over 50% at Morocco to 8-10mmscf/d. 

The size of the prize in Morocco is huge, as follows: 

Achieving full capacity of the current pipeline would produce 24,000MCF x $12 x 365 = $105m cashflow pa. 

$105m x 75% (75% ownership) = $78m of which $70m pa would be gross profit (as the costs are $1 per MCF) 

9 wells are to be funded from existing cash (which included part of the recent fundraise)

Todays date is the 27th January 2018, and we have completed five drills and four have been declared gas discoveries – coming in well ahead of pre-drill estimates

On 20th November, SDX announced the flow rates of their first discovery, KSR-14 and the results were fantastic, coming in at 6.4MMscfd which was well ahead of expectations and on its own could supply the entire sales to all customers! For the full announcement, see here

On 15th December, SDX announced the flow rates of their second discovery, KSR-15 and the results were even better, coming in at 7.52MMscfd which again, was well ahead of expectations and on its own could supply more than the entire sales to all customers! For the full announcement, see here. 

It gets even better than that because on the 11th December, SDX announced the third Gas Discovery, KSR-16 encountered the largest pay sand of all three wells to date. The “Hoot Pay Sand” encountered a whopping 14.2 meters of net conventional natural gas pay in the Hoot formation which was 50% more than expected! Flow results came in at a MASSIVE 8.43MMscfd! The announcement can be found here. 

Clearly this bodes well for the remaining 4 back to back drills and newsflow will be regular on drill results and flow rates, keeping investors very interested throughout January and even then it overlaps with South Disouq drilling all the way to end Q1 2018. 

The fourth well was called the ELQ-1 prospect on the Gharb Centre permit. This was an exploration well using Circle’s old 2D imagery. This well was a test to see if their old databank would be useful going forward. However, it did not discover commercial quantities and the well was plugged and abandoned. The remaining wells are using SDX’s recent 3D imagery and so will be ‘back to usual’. The announcement can be found here.

On 23rd January, SDX announced their fourth gas discovery, ONZ-7 and highlighted that whilst the 5m pay zone was in line with prognosis, the reservoir quality exceeded expectations encountering porosity in the pay section of 35.3%. The well will be tested in early Feb and results announced to the market. For the full announcement, see here

The rig has now moved on to the 6th well, KSS-2 which will spud shortly.

 

Here are the plans of the Morocco wells where you can see how close they are together and also where the pipeline runs through:

 

From the company:

 

 

So, there’s loads going on here and clearly regular large events to drive the SP upside towards the NAV and beyond. 

It’s important to be aware that the sales contracts to Morocco customers are 5 year contracts and so it’s not just about having the production to fulfil them, it’s also important to have the reserves to ensure they can fulfil the entire contract for the duration

Clearly the reserves will have exceeded expectations from the first three wells and these wells will be shut in at some point to establish the reserves estimates, which in turn will be announced with the year end results in Q1. 

In the meantime, the company is now pressing on with acquiring new customers and they plan to have at least half the pipeline filled. The customer demand in Morocco is huge as you can see from the slide above – those customers choosing SDX have a competitive edge over other who use imported bottled gas because bottles gas costs much higher ($18/MCF Vs SDX $12/MCF). 

SDX completed a survey when they acquired Circle assets and they found that customer demand was 44MMscfd which is DOUBLE the pipeline capacity of 24MMscfd. This bodes well for SDX and it’s all about nailing those reserves in order to fulfil new contracts. 

CEO Paul Welch explains this well in a recent interview which can be found here.

 

23rd January 2018 Operational Update & Analyst Visit 

SDX held an analysts visit to Morocco  on 23rd January 2018, and issued an operational update to shareholders which can be found here. 

I’ll summarise the points here to get a feel of what SDX are guiding for the coming 12 months: 

 

Investment Spend Programme: 

Here is a breakdown, by asset of the investment to be made in 2018 – (all NET to SDX contribution): 

Morocco $23m (the company refers to a $13m spend so far incl ONZ-7 but $23m is the full programme)

Meseda $3m

NW Gemsa $4.2m

South Disouq Drills $6.6m

South Disouq Pipeline $8.25m

South Ramadam $3m

 

Total Investment (spend) $48m

 

This is a significant budget to spend and is fully funded. As at 30th September 2017, SDX had a $57m working capital surplus of which $30m was cash. Much of the remaining surplus is owed to SDX by the authorities and can be drawn down in Egyptian Pounds to pay for the Egypt capital spend. Also, the government have made a commitment to repay all outstanding monies to O&G companies by end 2018. 

Furthermore, the company is generating cash so there is Q4 2017 and the whole of 2018 cash generation to add to the funds on the balance sheet so SDX are in an excellent financial position. 

 

Production Guidance following this investment: 

Here is a breakdown, by asset of the production guidance for 2018 – (all NET to SDX contribution): 

Morocco 1240 BOED

Meseda 731 BOED

NW Gemsa 2211 BOED

South Disouq 4600 BOED

 

Total 8800 BOED

 

This is a significant increase from the latest figure of 3700 BOED at the end of Q3 2017. 

The most Important thing here is that this figure does not include any contribution from the Kelvin & Ibn Yunus drills. These two drills are very significant and on success of both, it could add another 4000 BOED to South Disouq (net to SDX) in which case, taking the company production to nearly 13,000 BOED – This leaves huge upside to an already amazing 8800 BOED guidance! 

Also, if those wells do come in, then that opens up the door for them to be repeated with development wells much the same as SD-1X so the upside potential here is awesome.

 

Analyst Feedback 

The first analyst to feedback on the visit to Morocco is Malcome Graham-Wood (Malcy).  

Here is his feedback which can be found here: 

“I spent a few days with SDX Energy in Morocco this week along with a decent crowd of investment analysts which shows that the SDX story is rapidly gaining credence and depth. The story of SDX in Morocco is one of ‘simplicity made profitable’ as they describe it and from what we saw that is most definitely the case. The idea is to explore in shallow prospects, find gas, where at present they have an 80% success rate, transport it directly and sell the gas to the client on site. The gas needs little or no treatment being 99.6% methane and the potential client base is substantial. As a result margins are high, drilling costs are low and reducing all the time with rig procedure influenced by US onshore practices such as smaller, non concrete pads and biodegradable waste treatment. This has kept operating costs down, currently 30c per MCF there and thereabouts. The fiscal regime is also helpful with a ten year tax holiday and no royalties and contracts tend to be on a  5 year fixed price basis.

Gas prices are relatively high at $10/MCF with the Government pushing for this to be upped to $12, so at present each BCF is worth $10m probably escalating whenever contracts are renegotiated. So how does the potential market look like? Existing customers take 6 MMscfd and the pipeline capacity is 24 MMscfd so the scope is huge and with estimates of demand identified as 52 MMscfd one can see significant upside. There is significant cooperation with ONHYM who have the local knowledge, staff and experience and really appear to be extremely supportive, this can be seen in ‘Project Vingt Quatre’ which is the joint plan to fill up the pipeline which would quadruple cash flows. ONHYM also have the exploration background and relationships with the client base that also helps SDX considerably, their help towards SDX was obvious by the big turnout at very senior level at Wednesday’s dinner which was really good to see.

All this is possible as there is significant potential to grow reserves, needed for new customers or when wells start to see production declines. The company has identified 50+BCF of potential reserves which will be needed when one bears in mind a full pipeline and five year contracts. I would expect apart from the current 9 well programme, more 3D seismic and another drilling campaign to get underway later in the year.

Whilst in Morocco we saw a number of clients including the largest, Super Cerame where we visited a highly efficient factory producing a wide range of ceramics and also had a speech from the Director of CMCP (Subsidiary of International Paper) who produce both paper and cardboard and use significant quantities of gas with their drying techniques. We visited the Atlantic Free Zone (AFZ) which is attracting major clients such as Peugeot which is already a new customer connection, here SDX is considering installing a 7 way gas distribution hub in order to easily connect new customers attracted by the AFZ.  Later we were given a presentation by the MEDZ Free Zone at Kenitra who have a very credible existing footprint with a lot of signed up companies but there is room for many more.

We were able to visit a number of well sites, a couple that were in production and the recent discovery at ONZ-7 which is finishing off wireline and cement logging before going onto production shortly. There are four wells still to be drilled in this campaign, two development wells and two exploration wells further north at Lalla Mimouna. As mentioned there is an aggressive seismic plan in the Rharb Centre concession where potential leads can be established.

All in all the visit was undoubtedly a success, there is much going on and with a high degree of operational conversion there is little doubt that the market for this high margin gas is substantial. The company are targeting the upper end of 8-10 MMscfd by the end of the year and this should be easily attained. Nearly a year on from the Circle acquisition costs are down substantially (headcount down from 150+ to 35) in all areas, margins are up and growth looks increasingly likely.”

There are some very interesting points here, but the one that stands pout to me is that they are valuing Morocco at $10m per BCF and the company has identified a potential 50+ of BCF in their concession (that’s around $500m potential). This is massive news and really drives home the overall potential of SDX Energy. Remember this analysis is just for Morocco and as discussed above, Egypt has 2.5 TCF potential to tap into. It’s also important to remember the current MCAP is around £100m

 

2018 & 2019 Financial Forecasts

It’s always useful when writing blogs like this to include as much factual information as possible and when it comes to the financials, there is a very detailed report published by Progressive Equity Research (below). It's important to remember that Progressive issued this forecast before the company updated on its guidance on 23rd January so these will be revised up.

 

Progressive state that these are conservative figures and will be revised up based on the recent Morocco wells coming in way above expectations. 

Some highlights are: 

2018 Net Profit of $38.9m

2019 Net Profit of $50.6m 

Net Cash Balance end 2018 of $37.7m (after all capital/explorations costs) 

The cash balance rises to $80.2m in 2019 – that’s a serious amount of cash generation for a company with no debt.

 



 

Current Net Asset Value (NAV) Sum of Parts Valuation

  

Below is the company generated slide of the current NAV & RENAV. As you can see, the figures are $135m excl South Disouq rising to $180m with South Disouq.

Clearly these will be revised upwards based on the successes in 2017 outlined in this blog so far.

$180m works out to 80p per share – with even the fairest of winds, its easy to see how SDX could achieve my 2018 H1 target of £1.10 per share.

There are two things to note here:

Firstly, they are using a forward brent curve in the upper $50’s which now has the potential to grow much higher (given OPEC and Russia’s actions).

Secondly, this was pre-South Disouq discovery which is much bigger than thought and also Rabul2 Oil discovery was a surprise and finally, Morocco development has been expanded and currently coming in well ahead of expectations.

These Re-NAV figures will be revised up from $180m – significantly IMO.

 

From the company:

 

 

Medium Term Potential

 

Now that we’ve established the near-term potential … what does the medium term hold for SDX Energy? 

Management plan to drive production to 30,000 BOED through organic growth and acquisitions, the aim of which is to then agree a corporate buyout to an oil major.  

With the existing assets in Egypt and Morocco combined with the current cash, working capital and internal cash generation, it’s easy to see the path towards these large numbers. 

Based on the trajectory, I could see 2019 moving well above 18,000 BOED net to SDX supporting a £2.50 share price – this leaves loads of room for investors to enjoy the superb growth on offer from this excellent company with all of this being self-funded.

It’s always interesting to hear from the CEO himself and I think this interview in February is an ideal place to start and also gives a feel of his confidence

 

 

The company has an excellent PR strategy and most recent videos can be seen here

Finally, I finish off with an end of year interview with CEO Paul Welsh, reviewing the year of 2017 and what’s coming in 2018. This is a must watch interview which can be found on the front page of the SDX website here.

It’s interesting that the fundamentals of SDX Energy line up to current TA forecasts both in the short and medium term:

 

 



SDX Technical Analysis (TA) chart by bonker99


(Click to enlarge)



Brent crude oil Technical Analysis (TA) chart by bonker99


(Click to enlarge)

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