Africa Oil: Simplifying Balance Sheet While Reducing Cash Needs (TSX:AOI:CA)

Latest article on Africa Oil Corp. (OTCPK:AOIFF) discussed consolidating the main ownership under the company umbrella in exchange for company shares. Since then, management has continued to streamline its investments while reducing future cash needs. The result of these are carried interests in key areas, while the financial situation of the company will be a little easier to understand in the future. There is also a focus on areas that will be growth areas, while perhaps some more speculative (or uncertain) projects fall by the wayside as this process continues. Africa Oil has been, for a long time, a storied company that is one of the rare companies that has made the transition to a real operating entity with a very bright future and some impressive partners.

What made the transition possible was the association at the time with the Lundin Energy Group of Companies. That a sizeable organization is well respected for its track record with investors. But that association has now ended. The proposed combination not only simplifies the entire structure, but also puts another major (respected) shareholder behind the company to help this company continue to grow. It is hard to understate the need for this type of relationship when it comes to growing a small company in the offshore business.

Second trimester

Another announcement made earlier was a drilling campaign to add production to the company’s major production asset off the coast of Nigeria. This was going to disrupt ongoing production to some extent and the current results show that. However, breakeven results were overshadowed by a distribution from Prime and a reduction in net debt.

A combination of a different tax structure and the key transactions presented below affected both the comparisons and the reported results. Details are presented in the quarterly report. A combination of issues may continue to affect quarterly results until all of these issues are finalized, making quarterly comparisons a real challenge.

Africa Oil itself has no debt. However, Prime has debts that are being paid and therefore appear on Africa Oil’s consolidated balance sheet.

Perhaps the most important consideration is the structure and health of the company after all anticipated transactions are completed. The same goes for the drilling campaign.

Key transactions

This is a summary of the announcement during the fiscal quarter. After the end of the quarter, the company announced an offer to the minority shareholders of the subsidiary Impact to buy its shares.

All this activity makes the second quarter earnings announcement largely irrelevant. Once the drilling campaign is complete, production interruptions are no longer a concern and the steps outlined above are also completed, this will be a very different company going forward.

Management also announced an agreement to trade its nearly 15% stake in Eco (Atlantic) Oil & Gas Ltd. (OTCPK:ECAOF) for a 1% stake that Eco held in 3B/4B. This was part of the earnings announcement and further rationalizes the company’s holdings. As a result, this company now has interests only on the African continent.

In all of this Africa, oil itself will remain debt-free. The only issue would be the drilling campaign and how production issues as a result of that campaign affect cash flow and debt repayment going forward.

Business is moving forward

The transaction with Eco Atlantic will effectively end the business relationship with that company.

Any relatively small player in the offshore business will have down years and up years rather than a “straight line” up.

In this case, the most recent drilling campaign will provide an immediate increase in production (and cash flow) until the next campaign. Later, another project will come online and provide another source of cash flow. This diversification will provide the beginning of the company’s effort to smooth earnings.

It is harder to tell the effects on the stock price because the industry has been in the cage for some time. As a result, it may be worth waiting for the better years ahead as the industry could return to more normal historical valuations, which would provide upside potential even if production declines between drilling campaigns. There is also a potential for another incremental purchase using some cash flow.

The key part of the slide is the low capital required to reach the second source of production shown in the lower right corner of the slide.

Summary of future business

Africa Oil is a Canadian company reporting in US dollars.

One of the things that gives this company credibility for many of its size is the partners listed above. Both Chevron Corporation (CVX) and TotalEnergies SE (TTE) are well-regarded operators, elevating this offshore operator considerably above many offshore operators of the same size.

This could make the search for a “name” partner for the Equatorial Guinea project much easier than it would otherwise be.

The end of the minimization strategy in exchange for a working interest in a project is finally in the future.

The coming online of projects in South Africa and Namibia brings income located in two of the most advanced countries in Africa. They are also two of the most stable countries on the continent. This represents a higher valuation location than the current cash flow source location.

It will take some time for that future to arrive and start diversifying the cash flow. Therefore, this stock can be valued at the completion of the last drilling campaign. But there is much more potential for appreciation that is several years away.

The stock’s valuation will depend on market conditions at the time another project begins to contribute to the company’s overall production and profits. Overall, though, this is a small player with decent interests in some relatively large projects.

Summary

Between the drilling campaign affecting cash flow from a single cash source and all the simplification strategies announced, the company’s financials are very likely to undergo a major (positive) transition that will end with the consolidation of Prime within the company. Overall, each step seems to be a major plus for the company.

Africa Oil, as a smaller offshore operator, naturally has increased risk to the point where it is considered speculative at this point. However, for those who can handle the risk of a problem like this, it’s probably a strong buying idea. This company will likely be a materially different and much more valuable company by the end of a decade (and probably before). This is that rare company that makes the transition from a “story company” to an operating model.

Africa Oil itself has no debt. However, Prime has debt that it pays off and is consolidated on the balance sheet. That debt is at conservative levels. The low cash requirements needed to bring the next projects online (because a carry was negotiated) means the company will continue to have a strong balance sheet.

risks

Any upstream company is exposed to the volatility and low visibility of future oil prices. A sustained and severe decline in commodity prices could change the outlook for this company and some of its promising projects.

The ongoing drilling campaign has so far been successful. But success for the rest of the campaign is not assured.

Similarly, all simplification steps have the necessary approvals and administrative steps that must be successful. A review of all of this might find some unforeseen challenges to accomplishing all of the anticipated steps. It is unlikely. But it is a risk.

A loss of key personnel could significantly affect the company’s future prospects.

Editor’s Note: This article discusses one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.