IOG investment thesis
Investment decisions

IOG – Trick or treating in the North Sea

Introduction to IOG

IOG’s share price was a carousel of emotions this week. IOG published an RNS on Wednesday containing news that made the stock crash (56%). The next day, they replaced the CEO and COO. After that, news about stock purchases from the new management, and information about liquidity (the main concern of investors), IOG’s shares climbed 67% in 2 days.

Brief context about IOG

IOG is a natural gas producer in the North Sea. It has a market cap of £70MM and a €100MM bond (bullet) carrying a 9.5% + 3 months EURIBOR coupon. 

IOG started production in March 2022 after several years of developing the assets. However, it has not been an easy year for IOG as it has reported operating problems several times this year. As a consequence, its two-only producing assets (Blythe and Elgood) are producing less natural gas than initially expected. In the last update, the average 2H22 production was 28.6mmscf/d

In addition, they have compromised £80MM CAPEX for 2022 to develop Blythe, Elgood and Southwark. The last one has suffered several delays but it is expected to be online in December and produce around 40mmscf/d with 2 wells (A1 & A2) – internal educated guess

IOG map of assets MORAM
Source: IOG

The Wednesday RNS and related events

They published an RNS on Wednesday with news on operating and non-operating assets. It was followed by another RNS on Thursday informing the change of CEO & COO, and a last RNS on Friday morning with the interim purchases of stock.

Operating

The problems in their operating assets persist. Consequently, they have decided to stop them for 4 weeks (Two of them were already planned as the window for maintenance). Moreover, they cut Elgood reserves to 7.5Bcm. This is very bad news and it means that this field will probably stop producing next year. Otherwise 2024, it will depend on the decline rate that it has after reopening.

Furthermore, they revised its 2H22 guidance from 30-50 mmscf/d to 22-28 mmscf/d. Average 2H22 production to date of 28.6 mmscf/d, constrained by aqueous liquids production at Blythe, at an average realised price of 258 p/therm

Developing

They are working on Southwark that is expected to bring online around 40mmscf/d with 2 wells (A1 & A2)

Drilling in Southwark A1 has problems (drilling fluid losses) and they were suspending it for 2 months. Basically, they prefer to bring online the A2 well on time, and after that, they will work on A1. These 2 wells are not connected, so if A1 has problems, it does not impact A2.

Southwark A2 continues on track to be operating in mid-December.

The aftermath

After releasing this news, the stock tanked 56% as investors were mainly concerned about liquidity. 

Rupert Newall was named as the new CEO (he was the previous CFO) and Dougie Scott is joining the company as the new COO. (more than 30 years of background in different positions in the drilling industry and our feeling that in his current and accommodate position, there is no need for him to join IOG if he does not believe in the company) 

Mister Newall and the majority of his team purchased IOG stock on Thursday (Friday RNS)

Director/PDMRRoleNumber of Ordinary Shares purchasedResultant number of Ordinary Shares beneficially heldResultant percentage of issued share capital beneficially held
Fiona MacAulayChair49,178269,2180.05%
Rupert NewallCEO600,0004,407,0500.84%
Dougie ScottCOO192,289192,2890.04%
John ArthurCFO101,430101,4300.02%
James ChanceHead of Capital Markets & ESG107,526939,7250.18%

Some calculations about the IOG’s future

The market confidence in IOG was almost depleted due to its continuous operational problems over the year. Consequently, Wednesday’s RNS was the straw that filled the glass. The share price tanked 56% among concerns about liquidity and lack of confidence in the management & project. 

This is the second time they diminish the 2H22 guidance plus the news that the Elgood field is almost depleted.

As our main concern at this point is the liquidity issue, let’s have a look at the free cash flow & cash reserves for the rest of the year.

IOG Capex guidance is £70-85MM for FY22. And they announced that its cash position was £36MM (31 unrestricted + 5 restricted) on 19th October 2022.

We do not have the detail about the amount of Capex they have invested in 2H22. However, we know that they spent £21.63MM + £9.46MM in 1H22. The detail that we have is that the £9.46MM included in “Lease Liability Payments” in the 1H22 report is part of the CAPEX budget for 2022, so there is £46MM (middle point) of CAPEX to spend in 2H22. (Alxo & Momentum met with the IOG’s new management on Friday and we have been talking with Alxo about the company for the last weeks).

We have made some calculations about the liquidity in the next two months. This is a very simplified exercise with the data of 19th October. We assume no CER royalties (waiting for more information on this point), no 60 days to pay/get paid,…

MORAM -IOG liquidity calculations
Moram calculations

Although, the price of 280 p/therm in December could seem conservative (100€/MWh) and the calculations are simplified. Also, we cannot determine the total amount of Capex that has been spent from 1st July to 19th October, which is determinant at this point. We also assume that the royalty to CER is 0 in 2022.

It gives us an idea of the critical situation that IOG is facing in the next couple of months. It will depend on the NBP price in December and if they can bring online A2 in mid-December (20mmscf/d and we considered working half a month)

Having a look at the bond covenants, we see that there is no problem at the moment with them as they need to maintain 5MM cash restricted, interest cover ratio 5 times EBITDA and minimum leverage ratio 2.5:1 (net debt to EBITDA).

We also see that there is the option to issue a further €30 million of bonds, at the prevailing market rate at the time of any issue. These additional €30MM liquidity would be a life jacket for IOG, but we need to consider that due to its critical situation, the interest rates would be high yield/junk bonds. So probably, IOG would not be able to meet the second covenant and therefore, this is not an option.

Our take on the IOG situation

We believe that the CEO & COO changes are good for IOG. Mr Newell has been quick to send the correct messages to the market with the stock purchases by the management. Although in our view, it is an aesthetic movement, it showed two things. The first and very positive one, the CEO is a leader as we believe he persuaded his team to follow him with the movement. Second, there are not huge purchases (for their level), and we believe that everyone here is aware that IOG is in the ICU at this moment.

If Southwark (A2) starts in mid-December, and then they can put Southwark (A1) online in February. IOG will survive and this would have been a huge buying opportunity for investors. However, IF something more happens, IOG will need to increase capital. This would dilute and impact the future returns of investors significantly.

We had a small position and we increased it this week. We believe that the NBP will be considerably higher in December and the A2 well will work well & on time. Nevertheless, our perspectives are not the same as they were some days ago. We are going to closely monitor IOG as we are aware that the risk level we are taking is elevated. 

Note: Every week we publish investment thesis,macroeconomic articles and comments on the market situation in the recently launched blog section. You can follow us to receive an email each Sunday with the publications of the week. 

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