Description

This write up basically asks the following question: What is the appropriate discount for a Colombian E&P that has had an outstanding track record in finding and developing oil?   In this market the valuation stands at ~2.3X EBITDA or a 30% FCF yield at $65 Brent. If one feels this is appropriate, then this is basically a value trap amid the rest of the cheap valuations in the energy space.

Geopark is a Latin American E&P with an outstanding track record of growing production using internally generated cash flows.  It currently produces ~40K BOE (86% oil) with 33K BOE coming from its low-cost operations in Colombia and the remainder from smaller assets in Peru, Ecuador, Chile, Argentina and Brazil.  It has grown production by 18% CAGR over the past 10 years through 2019.  2020 production was flat vs. 2019 and 2021 will also be flat as a result of disruptions/transportation blockades in the second qtr due to political strife in Colombia which curtailed 2nd qtr 2021 production by 3000 bbls per day.  As a result the shares now trade at 2.3X EV/EBITDA and a ~30% 2022 FCF yield.

Valuation and Cap Structure

The company has a simple capital structure.  $170M in 6.5% 2024 notes that it intends to gradually redeem with internally generated cash flows through 2024 and $500M in newly issued 5.5% 2027 notes.  As of 6/30 it also had $85M in cash for net debt of $585M.

2022 EBITDA estimates at $65 Brent are ~$475M.  Maintenance cap is $135M and they are likely to spend another ~$50M a year in 2022 and beyond on exploration to try to grow.  (75% of their past exploration wells have been successful.)  Once the 2024 notes are paid off Management is comfortable with the 1-1.2X leverage with just the 2027 notes and intends to use all other FCF to pay dividends and buy back stock.  Its 2P NAV10 was $31 according to reserves report in 2020.  Clearly the market doesn’t believe this number and assigns little terminal value to its undeveloped 2P reserves.  Its 1P NAV10 is $17 per share.  The company has recently doubled its qtrly dividend to 4.1 cents and has restarted its buyback.    

Operational Highlights

Geopark has produced outstanding exploration results in the past 5 years.  Highlights include:

1)  It has replaced 2P reserves since 2015 at a rate of 193%. 

2)  It has had average finding costs of $4.50 per barrel in the same 2015-2020 period with a recycle ratio of 4-7x since 2015.  Its 2P reserve life Index is 11.9 years with 1P reserve life at 7.4 years.

3)  Its operating costs in its core Colombian are in the $7- $7.50 range.  G&A and exploration costs avg $5 per BOE and transportation expenses are ~$8.  Cash and in kind royalties avg 20% of Brent crude prices.  Breakeven price is below $30 Brent!

4)  Its conventional resources feature much lower declines vs. shale assets and while cap ex to sustain 40K BOE level is approximately $130M.    At a $42 Brent average price in 2020 its EBITDA  was $275M and while cap ex was dropped to $75M.  Going forward my estimates to hold production flat is $130M in cap ex.  Flat Production in 2021 does not include any success from exploration wells.  

Why Does the Opportunity Exist

2021 has hitherto been difficult for the company due to two issues aside from generally depressed energy valuations: An internal feud between its co-founders and the general political strife in Colombia which has affected all Colombian oil companies (Parex, Frontera, EcoPetrol, and Gran Tierra).  As a result, the shares have been relegated to the dust bin with the rest of the Energy space. 

Internal Management Issues

The CEO and Co Founder James Park controls 8.3M or 13.6% of the company while the ousted Chairman Gerald O’Shaughnessy owns 6.54M or 10.7% of the outstanding shares.  The latter wanted to sell the company and had pledged all his shares of company stock for a margin loan.  The former led the rest of the board in removing O’Shaughnessy as Chairman.  O’Shaughnessy’s behavior had become erratic as he had threatened to resign from board twice only to rescind the proposed resignations.  The proxy battle has been settled with the CEO James Park prevailing.  Some investors may still fear an overhang remains from O’Shaughnessy potentially seeking to unload his stake in the future if the company remains independent.  M&A is possible but unlikely here in the short term as James Park is unlikely to sell before he grows the production base. (Parex which trades at ~3x EBITDA is the logical buyer as it owns 55% working interest in the LLA-34 block that produces 77K BOE a day while GeoPark is the operator)

Colombian Political Strife  

In Q2 Colombia faced the longest and most destructive mass protests in recent history. The protests, which began on April 28, 2021, were triggered by a tax-reform bill proposed by the government to stabilize public debt and fiscal deficit. Despite the bill’s removal on May 2, 2021, protests continued and expanded, becoming a broad call for improvements in other areas. To date, dozens of people have died, and thousands have been injured.  The strikes ended on June 6th.  All the blockades of company production have been resolved and all production is back online.  These protests have created an additional discount to GPRK and all other Colombian producers. 

Why GRPK vs. other Colombian E&Ps - Aligned Incentives – Owner Operator

Aside from its outstanding operational record and low finding costs, GPRK offers equity holders the chance to invest alongside a CEO who has more than just a little SKIN in the game.  The CEO’s 8.3M shares offer much more upside in terms of wealth generation than what he can achieve by overcompensating himself (Shale operators have been egregious in this regard).  I believe he will continue to run the company as an owner operator who is determined to grow production while distributing cash to holders.  The other reason to own GPRK over Parex Resources is because Parex trades at slightly higher valuation and has no debt (net cash of $350M) and therefore much less equity leverage. Investors who want less Beta and prefer safety would likely choose Parex.  Both face the same country risk.

COVID and the recent political problems have certainly put a brake on their growth plans in 2021 but 2022 is shaping as a potential return to their previous plan of organic growth through exploration alongside further development at CPO-5 and LLA-34.

Operations

Colombia  

LLA 34 – This exploration block was developed by GPRK and is operated by the company although its larger peer Parex Resources holds a 55% working interest and has funded the majority of the cap ex spend.  The block has simply been a gold mine for both companies as it is currently producing more than 75K bbls of oil at a $7 cost.  New wells now cost $3.5M to drill and produce north of 1.5MM cumulative barrels of oil.  The company has a 2P reserve life of 10.6 years on this incredible area and break evens are $14-$15 at field level including cap ex.  The company’s August presentation has more details on this incredible asset.

CPO-5 – This block was acquired through the acquisition of Amerisur in late 2019 and is operator by Indian National Oil Comp (ONGC).  GPRK holds a 30% working interest in this area.  To date only a couple of wells have been drilled here but the results have simply been astonishing.  The Mariposa well drilled in 2019 has produced 2.1MM of OIL in 23 months and is currently producing 7K BOPD while the Indico well has produced 3M BOPD in the first 26 months and is still producing 5,100 BOPD.  The most recent well drilled, the Indico 2, has tested at 5,500 BOPD and is now online and producing 6,200 BOPD! ONGC is ramping up drilling in this area in the 4th qtr of this year and at a cost of $8M per well, returns here if similar to initial wells will boost production and profitability in a prolific manner in 2022.

Platanillo Block – This is another area they received in the purchase of Amerisur in Colombia that has upside exploration potential going forward but in the short term is not an area of focus.  This area is producing about 4,300 BOE per day.

Brazil

Manati Gas Field – This field produced 11K MCFpd in Q2 and $3.5M in EBITDA.  The company has agreed to sell this asset for $27M with sale expected to close in Q4.  Proceeds of the sale will likely be used to retire a portion of its 2024 notes.

Chile/Argentina

These assets are considered non core and the company is exploring a sale of the Argentine assets and may eventually exit Chile as well.  They produced about 4K BOE per day in Q2 with only 25% oil production.  Combined, these assets produced less than 5% of the company’s EBITDA.

Exploration Assets

Llanos 87 & Llanos 114 – Alongside the non operated position in CPO-5 these two adjacent areas to its Llanos – 34 block will be drilled in the upcoming quarters.  Management is very upbeat regarding the potential in these areas as they are similar to LLA-34.  Included in cap ex guidance for the next year is 5-10 exploration wells in this area that could yield material upside to its reserve base, which is a key concern for all Colombian operators.  Success here would only materially increase the 1P NAV of $17 per share at year 2020 prices not CURRENT STRIP.  Its 2P NAV at year end prices was $31.

Conclusion

GPRK is not a difficult story to follow once we dig past its non core assets outside of Colombia and focus on its cash cow position in Colombia and the large potential upside from adjacent Colombian blocks, LLA-87 and LLA-134, and its non operated CPO-5 block.  The valuation here is implying the company’s assets will be worthless in 5 years given it can generate its entire EV in FCF over the next 5 years at current strip pricing.  Estimates for next year stand at $475M in EBITDA with cap ex estimated to remain flat at ~$135M.  It currently trades at a $1.3B EV with $715M equity cap and net debt of $585M. The company is trading at a 30% FCF yield on 2022 numbers.  This valuation is for a company that has had a strong record of exploration success and production growth for more than a decade.   No production from its exploration wells are included in this year and next year’s EBITDA estimates.  These numbers could improve markedly if the company is successful in its exploration program over the next year.  

Catalysts 

Following the refinancing of its debt the company has recently doubled its dividend and has restarted its buyback program.  At current prices, the company can buy back 50% of its shares in the next two years while still paying off its 2024 notes in full.  

M&A – Given its current valuation the company would be an ideal target for Parex to consolidate its position in Colombia.  A deal would result in significant synergies and it is likely that the Co-founder O’Shaughnessy was trying to engineer one.

Exploration Success in LLA-34 adjacent blocks in Colombia.

Risks

Colombian Political risks – This is at the heart of whether this is a value stock or not. The country risk here is hard to handicap.  Colombia has been volatile in the past but E&P companies have operated with little interference in the country for more than a decade.  As a guide one could look at Colombian sovereign spreads which are 200 Bps over Treasuries as a guideline to determine appropriate discount.  However, some investors with long memories of investing in Venezuela will likely never touch South American E&Ps.  The recent flare up in Colombia has highlighted the potential for instability in the area and is clearly reflected in the valuation.

Limited reserve life – The company’s 2P reserve life of 11 years is also an issue for some investors.

General decline in Oil prices

ESG Discount

Catalyst

Following the refinancing of its debt the company has recently doubled its dividend and has restarted its buyback program.  At current prices, the company can buy back 50% of its shares in the next two years while still paying off its 2024 notes in full.  

M&A – Given its current valuation the company would be an ideal target for Parex to consolidate its position in Colombia.  A deal would result in significant synergies and it is likely that the Co-founder O’Shaughnessy was trying to engineer one.

Exploration Success in LLA-34 adjacent blocks in Colombia.