The Colombian, Caribbean Coast gas market is expected to move into gas deficit in the absence of LNG imports, incremental piped gas or the development of recent deepwater discoveries. We expect Canacol’s market share to increase materially in 2019 and 2020, with management expecting production to ramp-up to 215mmscfd by mid-2019 (+89% from FY18). This is currently underpinned by a YE18 2P reserve base of c 559bcf, implying a reserve life index (RLI) of 7.1 years at 215mmscfd. High exploration and appraisal success rates (historically above 80%) and over 2.6tcf of unrisked prospective resource should enable Canacol to enhance RLI and provide the basis for further production expansion. Realised gas prices are largely fixed (forecast FY19 c US$4.75/mcf post-transport and pre-tax netback of US$3.73/mcf), providing visibility of free cash flows. Our 2P + risked exploration NAV stands at C$6.28/share.
With over 2.6tcf of net unrisked prospective resource (Gaffney Cline estimated Pmean), Canacol has sufficient acreage to continue to replace produced reserves while extending and enhancing production plateau. Additions are likely to be key drivers of NAV, as prospective resource is converted to behind-pipe reserves.
At forecast FY20 215mmscfd plateau production, we estimate that Canacol will be generating annual free cash flow (FCF) of US$170m after interest and maintenance capex (capex required to replace produced reserves). With our net debt forecast at 1.5x EBITDA at end FY19, capacity exists to expand the exploration programme, in addition to potential shareholder cash returns. Indicatively, assuming Canacol pursues a policy of shareholder distributions broadly in line with peers, this would imply a cash return yield of c 3.7% for FY20.
Edison has valued Canacol using a conventional E&P risked NAV approach, with a base case valuation of C$6.28/share. Canacol currently trades at FY20 (post-rampup) P/CF 3.8x, versus its Canadian peers on 2.5x. We believe this premium is driven by certainty of price realisations, strong FCF yield and high production growth relative to peers. Key risks are around Canacol’s ability to replace reserves, somewhat mitigated by its strong track record of exploration success. Colombian geopolitical risk will drive differentiated views on cost of capital; we provide sensitivities to this key valuation input using 12.5% in our base case.