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GSS Energy &ndash Unique And Interesting Business Model
CORPORATE DIGEST | 13 FEBRUARY 2015
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Pursuant to my writeup on GSS Energy (formerly known as Giken Sakata) on 1 Oct 2014 (see writeup here), GSS Energy has weakened from $0.315 to a low of $0.245 in mid January before closing at $0.270 on 27 January 2015.
This was down 14 percent as compared to 1 October 2014. To put into perspective, Rex and RH Petrogas have fallen about 33 percent and 44 percent respectively over the same period.
At the time of doing this writeup, GSS Energy has been suspended from trading due to its proposed restructuring by way of a scheme of arrangement. It will resume trading under the name of GSS Energy Limited. It closed at $0.270 on 27 January 2015 before the suspension.
As one of GSS Energy&rsquo s main businesses is oil production, the > 50 percent slump in oil price has led many investors to reconsider its business prospects.
Impact On Oil Price Slump Manageable
GSS Energy sells their oil to Pertamina and the selling price is fixed for a year, subject to an annual review by Pertamina. According to management, if Pertamina wishes to change the selling price, it also has to change the USD/IDR FX rate.
In other words, Pertamina can either keep the selling price unchanged, or change both the selling price as well as the USD/IDR FX rate.
USD/IDR has appreciated approximately 41 percent from USD/IDR 9,000 (their last contracted rate) to 12,700. Thus, the favourable move in USD/IDR is likely to mitigate the possible fall in their selling price to some extent.
Senergy Report On Three Oil Fields &ndash A Near Term Catalyst
Senergy is likely to release the valuation report on GSS Energy&rsquo s three fields (Kawengan, Trembul and Gabus) in 1Q 2015.
For their first two fields, namely D& W and Tunggul oil fields, Senergy valued them on the best scenario net present value of US$195 million, or $263 million based on a 10 percent discount rate. (See Table 1 below)
Table 1: Projected net present value of D& W and Tungkul fields using a 10 percent discount rate
Kawengan, Trembul and Gabus fields have at least 161 oil wells vs the 131 wells from the D& W and Tungkul fields.
In addition, according to management, Trembul and Gabus fields have deeper oil wells than the other fields, providing greater potential for the production of oil.
Thus, it is likely that the three fields should fetch a higher valuation (notwithstanding the drop in the oil price) than D& W and Tunggul oil fields.
With both valuation reports on GSS Energy&rsquo s five fields, this should shed some light on its reserves valuation and reflect the stark difference between reserves valuation and its market capitalization currently valued at $128 million as of 27 Jan 2015.
Takes Delivery Of Three More Rigs This Year
As of end Nov 2014, GSS Energy produced about 1,070 barrels of oil per day. According to DMG report dated Jan 2015, GSS Energy has one land rig in operation and is expected to take delivery of three land rigs in 2015.
This should increase their oil production in the months ahead.
Precision Engineering Business Performed Well In 2014
Giken&rsquo s FY14 revenue from its precision engineering business dropped 46 percent from $126.8 million in FY13 to $69.0 million in FY14.
However, net profit soared 475 percent from $446K in FY13 to $2.1 million in FY14. According to their FY14 results press release, management is positive on its contract manufacturing business which should bode well for their FY15F results.
1HFY15F And FY15F Results Likely To Be Strong
Besides the positive outlook on GSS Energy&rsquo s precision engineering business, there will be maiden contribution from its oil business in 1HFY15F results onwards.
Ceteris paribus, FY15F should be a better year for GSS.
Valuation
After my writeup on GSS Energy on 1 Oct 2014, DMG Securities and Religare have initiated coverage with target prices of $0.650 and $0.510 respectively (See Table 1 below).
Personally, it would be good if Senergy release the valuation report on the other three fields. This would serve as an alternative independent valuation yard stick for the investors.
Table 1: GSS analysts&rsquo target price
Giken&rsquo s Chart Analysis
Based on Chart 1 below, GSS Energy has been entrenched in a downtrend since Jun 2014. It has to breach the strong resistance around $0.290 &ndash 0.300 with volume expansion for the chart to turn positive.
Near term supports and resistances are at $0.260 &ndash 0.265 / 0.245 & $0.280 / 0.290 &ndash 0.300 respectively.
Chart 1: GSS entrenched in a strong downtrend
Conclusion &ndash Unique business model, less affected by swings in oil price
In a nutshell, although one of GSS Energy business segments (i.e. oil production) is the least favoured sector now, there is some merit in GSS Energy oil business model.
It is noteworthy that the > 50% slump in oil price may not affect GSS Energy to such a large extent.
However, in order for GSS Energy share price to re-rate, it depends on the company&rsquo s FY15F results, Senergy&rsquo s report on its three fields and management&rsquo s communication of their unique business model to the investment community.
Readers who are interested should take a look at their website for more information. You can also email me at [email protected] for the analyst reports on GSS.
Formerly known as Giken Sakata, it has transformed itself from an integrated contract manufacturer to an oil producer while still retaining precision engineering business. Attached is an article on the company for those who are interested.
Most people would have shunned the following stock, given that it has skyrocketed 800 percent from $0.035 on 18 Feb 14 to $0.315 on 1 Oct 14. This is notwithstanding the series of shares placement which Giken Sakata (Giken) has done since Feb. Chart 1: Giken has skyrocketed 800 percent since 18 Feb 14 
Source: CIMB chart as of 1 Oct 14 What Piqued My Interest? Giken seems to be a potential onshore Indonesia oil play. After doing some research on Giken, armed with my queries, I decided to connect with Giken&rsquo s management to understand more about their company and their prospects. Mr Sydney Yeung, CEO of Giken (&ldquo Management&rdquo ) promptly agreed to meet me for an exclusive chat over coffee.
For their onshore oil production business, Giken, through PT Cepu operates through the following manner: a) Pertamina, Indonesia&rsquo s state-owned oil and gas company signs a Mother Agreement with the local co-operatives (e.g. KUD / BUMD) b) The local co-operatives will sign a Cooperative Agreement with PT Cepu (i.e. Giken) to produce oil. The revenue split for this cooperative arrangement is typically 20 percent (local co-operatives) and 80 percent (PT Cepu). According to Management, Giken is the only player in this old wells programme for the whole of Indonesia. They believe that the above arrangement is beneficial to all three parties. Firstly, the oil produced from the old wells must be sold to Pertamina at approximately 70 percent of Indonesian crude price (&ldquo ICP&rdquo ). Without this arrangement, Pertamina would have to source the oil from other parties, which is likely to be on less favourable prices. Secondly, the local co-operatives which are the local governments would stand to benefit from the arrangement. Their villagers would be able to enjoy a higher standard of living, as some of them would be employed by Giken. The local governments would also be able to enjoy 20 percent of the revenue obtained from the sale of oil to Pertamina. Thirdly, for Giken, they have nothing to lose. Their production cost is about US$20 / barrel of oil, thus the profit margin is still considerable, despite the revenue split between local co-operatives and Giken and the discounted selling price of the oil to Pertamina. In addition, Giken has less business risk as they have a guaranteed buyer i.e. Pertamina.
Giken utilizes &ldquo twinning&rdquo strategy where they drill new wells beside the old wells. These new wells are sturdier, more operation friendly and can be deeper than the old wells to increase the yield on each well. As the new wells are drilled beside the old wells which were previously producing, exploration risk is minimal.
According to management, their business model and strategy offer a short payback period of approximately 5-6 months. Once the oil wells start producing, it generates cash flow immediately. Capex is low for each well as these are simple onshore wells. Management estimates the capex for each well to be approximately US$120,000-160,000. Part of the drilling capex can be funded by its existing production.
With reference to Giken&rsquo s announcement on 22 Sep 14, Giken stated that it has increased its production from its Dandingilo-Wonocolo (&ldquo D& W&rdquo ) and Tungkul fields by 31 percent from (14 wells) 670 barrels of crude oil per day (&ldquo bopd&rdquo ) in June 14 to (15 wells) 880 bopd in Sep 14. There are two noteworthy points on the above figures. a) The above production update only pertains to 15 wells from D& W and Tungkul fields. D& W and Tungkul fields have a total of 139 wells. b) As mentioned above, the production update pertains to D& W and Tungkul fields. Giken has a total of five fields now with a combined number of 300 wells. Even without new expansion, there is likely to be enough work for Giken for several years. Going forward, management expects to drill three to four wells each month. This should speed up production and subsequently their profitability. Management added that they may consider building tank farms once their production hit a significant level.
Pertamina fixes the selling price of the oil at approximately 70 percent of ICP. According to management, this price is reset annually. Naturally, there are both positive and negative aspects to such an arrangement. However, my personal view is that with this arrangement, there is some stability to Giken&rsquo s business operations, unlike other oil & gas plays which may be extremely vulnerable to short term swings in oil prices.
There was a valuation report prepared by Senergy Oil & Gas (Singapore) Pte Ltd (&ldquo Senergy&rdquo ) which valued the D& W and Tungkul fields to be worth a (best scenario) net present value of US$195m based on a 10 percent discount rate (See Table 1 below). 
With reference to Giken&rsquo s announcement today, Giken has commissioned Senergy to prepare a reserve report on Kawengan, Trembul and Gabus fields. It is noteworthy that Kawengan, Trembul and Gabus fields have a total of 161 wells vs the 131 wells from the D& W and Tungkul fields. Furthermore, according to management, their data showed that Trembul and Gabus fields have deeper oil wells than the other fields, providing greater potential for the production of oil. Thus, based on my (purely) layman perspective, the Senergy reserve report on Kawengan, Trembul and Gabus fields may likely yield a figure comparable to US$195m, similar to that of D& W and Tungkul fields. This is likely to (at least) add some assurance to Giken&rsquo s shareholders and may raise the overall valuation of Giken.
Indonesia, a former OPEC member, has been a net exporter of oil till 2008 where they became a net importer. Falling oil production has hit Indonesia hard. Thus, they are likely to continue their push towards increasing domestic oil production which should bode well for Giken. It is noteworthy that Indonesia has more than 10,000 old wells, thus the growth opportunity for Giken is significant.
Giken&rsquo s 1HFY14 revenue and net profit from the contract manufacturing business were S$38.5m and S$708K respectively. Although their contract manufacturing business environment is likely to continue to be competitive, management expects their results to gradually improve in the next two years. Jokowi To Suspend Operations At Pertamina Unit &rarr No Impact To Giken With reference to a Business Times article on 24 Sep, it was reported that Mr Joko Widodo plans to halt operations at Pertamina&rsquo s energy trading unit Petral. However, according to management, this has no impact to Giken as they do not deal with Petral. &lrm They sell their oil only directly to Pertamina and not its subsidiaries. Investment Risks Customer Concentration Risk For the oil produced, Giken can only sell to Pertamina who has the right to set the selling price and the exchange rate. Although there seems to be a large customer concentration risk on Giken&rsquo s aspect, I will like to draw readers&rsquo attention to the following points which may alleviate the risk to a certain extent: a) Pertamina is buying a minuscule portion of the oil it requires from Giken. Even if Pertamina prices the oil at 70 percent discount to ICP, it is unlikely to result in meaningful cost savings for Pertamina. b) Giken is the only player in this old wells programme for the whole of Indonesia. Furthermore, Indonesia has more than 10,000 old wells, and as Indonesia is looking to increase their domestic production, it is likely that Pertamina wants a cordial working relationship with Giken. Ability To Extend Agreements The ability for Giken to extend the Cooperative Agreement with the local co-operatives and to sign new Cooperative Agreement are key factors for Giken&rsquo s long term growth. Furthermore, the ability for the renewal of the Mother Agreement between Pertamina and the local co-operatives is important too. It is noteworthy that Giken is currently producing oil from 15 wells out of their 300 wells. Even without new Cooperative Agreements, there is likely to be enough work for Giken for several years. Limited Track Record In Producing Oil Based on limited published figures, Giken&rsquo s oil production has risen from 300 bopd to 880 bopd in less than six months. However, there is limited data (we need more data over time) to ascertain management&rsquo s track record in oil production. Foreign Country Risk Giken&rsquo s onshore oil business operates in Indonesia hence they are subject to Indonesia&rsquo s politics, laws and regulations. Any adverse change in the above factors is likely to have a negative impact to Giken. Senergy Report Based on Table 1 above, although Senergy estimated that D& W and Tungkul fields are worth a (best scenario) net present value of US$195m based on a 10 percent discount rate, it is noteworthy that the actual stake Giken has in the fields are likely to be worth less than US$195m. See Figure 1 below on the corporate structure. 
Source: Company, Voyage Research Limited Analyst Coverage Only Voyage Research covers Giken with a potential price of $0.450. I.e. there is limited analyst coverage. It is reasonable to say that the investment community is still not familiar with Giken, especially to its foray into the onshore oilfield in Indonesia. Management is cognizant and is doing their best to raise the awareness of the investment community on Giken. Giken&rsquo s Chart Analysis Based on Chart 1 above, Giken has been trading within the range of $0.315 &ndash $0.360 since 9 Jun 14. It seems to be testing the support of $0.315-0.320. A sustained break below $0.315 points to a measured technical target price of around $0.275. However, there are multiple levels of support from $0.300 &ndash 0.310 due to the placement price at $0.300, Fibonacci level and 100D EMA. Resistances are at $0.330 &ndash 0.335 / $0.350 &ndash 0.360. A break above $0.360 negates the slight negative bias of the chart. Conclusion &ndash This Is Just An Introduction In short, Giken seems to be a budding Indonesia onshore oil play. Short payback period, cash flow generative operations, guaranteed customer and favourable Indonesia dynamics etc. are points which interest me. However, it is noteworthy that customer concentration risk, ability to extend agreements and limited track record are some factors which readers should be aware of. |
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