Why I bought Kosmos Energy

Posted By: EN Todayon: July 06, 2023In: General Energy News

grandriver

I have a Income Bucket in my actively invested portfolio and an Upside Bucket. Their names describe their purpose pretty well.

Most of my writing is centered around the Income Bucket. It is four times as big as The Upside Bucket and is my primary defense against a repeat of the 1970s.

If I cannot find a better alternative, I will sometimes hold both stocks. Three months ago, I did the same thing with Tourmaline.

Recently, I closed this position with a gain of 14% and invested the funds in Kosmos ( NYSE KOS). This article will explain how and why I made that decision.

Kosmos Energy is a company that focuses on offshore oil production and development. They generally work in partnership with other firms, often large ones such as BP (BP).

Today, they are active in Ghana, Equatorial Guyana, and the Gulf of Mexico. In Q1, the net production was 59,000 BOE/d. BOE is a barrel of energy. Other gases and fluids are normalized to oil. )

Kosmos Energy

They are also partners in the “Tortue”, a major gas field located off Mauritania, Senegal and Senegal. The first LNG is expected to be produced in Q1 of 2024.

A Second Valuation As a Trigger

Michael Boyd, the SA Investing Group’s CEO, runs Energy Investing Authority. Michael runs discounted cash flow (DCF) models for each company in his coverage universe using his industry knowledge. He covers 29 upstream companies in the US, and 19 in Canada. He also covers midstream companies.

DCF models are developed for upstream energy companies using a discount rate of 10% and current strip prices. The target prices are then calculated for each company. Michael’s estimation of future production volume for each firm is reflected in the model.

If you take these target prices to be a fair value, then the different firms tends to move in tandem on either side of the market. Recent average gains for US upstream companies have been around 20%.

Or perhaps the whole sector will improve in time. Maybe oil prices will fall and all of them will go down. Time will tell.

It is more interesting to me that some stocks can move up in price at a rate that suggests a far greater upside than average. These differences tend to diminish over time after such movements, resulting in significant gains for those who invest.

KOS recently showed a rise above 70% when the average at the time was only 19%. Although I do not chase 10% deviations, when the increase in one stock from Michael’s models is more than three times higher than the current average my experience is that there is likely something real.

It is important to look into the discrepancy. I will never buy a stock that I am not willing to hold for the long term, but I do often purchase in hopes of making substantial gains within one or two years.

My View on the Kosmos Story

Michael has highlighted in recent articles , that Kosmos nears the end of an era of high capital intensity. Kosmos will soon reap the rewards of significant increases in production. He believes that DACF (Debt Adjusted cash flow) will increase by 30% between 2023 and 2024.

In the Kosmos Investor Presentation as well as in a recent Article from FluidsDoc, this upward trend in production and revenue is also clearly visible.

The press release that accompanied Q1 earnings is quoted below:

Andrew G. Inglis, Chief Executive Officer of Kosmos, said: “Kosmos delivered a solid performance in first quarter and moved closer to the anticipated mid-year inflection point for free cash flow. Three development projects are underway to increase production levels by 50%.

FluidsDoc’s price target in April, when the price of the product was $8, was well above Michaels’ value of $9.50.

YCharts

KOS’s price has been falling since the beginning of May. The price today is less than $6. I can’t see a good reason and think that the markets are acting irrationally, just like Benjamin Graham or Howard Marks. It is not surprising when one considers how poor the quality of human thought is and the numerous incentives that push institutional investors to ignore fair value.

The market is often slow to recognize the true value of such developments until they become real. Investors who think that current earnings alone represent intrinsic value are likely to miss out on opportunities.

I believe that pricing KOS in the $5-$8 range does not give them credit for their upcoming increase in production. The increase in production will likely be realized in the next year along with a change in the free cash flow. The market will likely give credit to the stock in due time.

I purchased KOS for $5.48. Theoretically, I’ll sell my KOS after a 50% gain.

The risks

KOS, with a price of around $50 per barrel, is not the lowest-cost producer. Oil prices falling would cause their profits to be reduced or eliminated while the dip lasted. This would have a negative impact on stock prices.

KOS’s current price is extremely low, but on a midcycle and in light of their production increases within the next 12 months, it is a very good deal. A further boost will be provided by their new projects, which will reduce their production costs.

There are of course also the political risks that come with offshore oil. Kosmos has a number of different countries in its portfolio, and I appreciate that they can change their focus depending on the treatment they receive.

Who Should invest?

Kosmos’s size is small, and its price is volatile. Do not invest if you cannot tolerate the risk.

They have not paid a dividend in some time and won’t for a few years. The Net Debt/EBITDA ratio is higher than 2x. This is not the place where E&Ps would like to be. Before any shareholder return, you will have to pay down the debt. Do not invest funds that you will need to receive dividends in the near future.

Investors looking for growth may be interested in KOS. The growth that is coming will not be unabated. The next opportunity to grow will be found by them, but it is impossible to predict what will happen.

The assets that they are currently developing should have a very long life and a value well above what it is now. Investors who are looking for positions that will likely have a substantial increase in value within a few years would be the best candidates to purchase KOS. It’s the reason I bought it.