African Queen hits the rocks – James Faulkner on Afren

Shares in Africa-focused oil E&P firm Afren (AFR) plunged by more than a quarter last week after it was revealed that it had suspended its chief executive and chief operating officer following the discovery of what it called “unauthorised payments” having been potentially made for the pair’s benefit.

In a statement last Thursday, Afren stressed that the payments were not made by the company, and that the investigation “has not found any evidence that any other Board members were involved”. It also noted that there was “no reason to believe that this will negatively affect the Company’s stated financial and operational position”, although the fact that publication of the company’s interims will be postponed didn’t exactly fill the market with confidence.

In the meantime, Afren’s founder and non-executive chairman, Egbert Imomoh, has agreed to become the group’s executive chairman, while senior non-executive director Toby Hayward – that’s Toby, not Tony Hayward of BP fame (or infamy) – will become interim chief executive.

The question for investors is whether the alleged wrongdoings are confined to the CEO and COO, as the company suggests, or whether this is indicative of some deeper issues with corporate governance at Afren.

It is certainly true that this is not the first time Afren’s senior management have come under scrutiny from a corporate governance perspective. In 2010 some of Afren’s top management invested about $1.3 million of their own money into First Hydrocarbon Nigeria, at $0.13 per share; subsequently in 2013, Afren acquired an additional 23.3% stake in First Hydrocarbon Nigeria (FHN), by that time a subsidiary company of Afren, for a total consideration of $105.4 million ($3.10 per share), effectively leaving management sitting on a paper profit of almost $23 million. While the transactions were conducted within the letter of the law, they certainly helped to undermine trust between shareholders and management; and recent events will have only served to vindicate and even reinforce those suspicions.

However, my guess is that the board will use this as an opportunity for a clearout in order to re-establish some credibility here. If so, this could prove an interesting buying opportunity for what is clearly an attractive strategic asset.

International investment is flowing into the African oil & gas sector at a record pace, as both emerging giants like China and Western powers look to secure future sources of energy. East Africa in particular is becoming a focus of future exploration activity, and Afren has already built up a sizeable portfolio of prospects in this region. Meanwhile, its production base in West Africa furnishes Afren with high levels of cash flow and the potential for near-term production growth.

The jewel in the crown, however, is the world-class Simrit discovery in Kurdistan, where the recently drilled Simrit-3 well tested at rates of more than 6,200 bopd (barrels of oil per day). It is also involved in the development of the Barda Rash field, also in Kurdistan, where recent drilling saw cumulative flow rates of 7,850 bopd. Of course, these regions are not without significant geo-political and operating risk, but they are nevertheless the ‘frontier’ regions of the oil industry and look set to provide some of the big discoveries of the next few years.

The question for investors is whether the current price offers value – after accounting for those risks. We think it does.

A recent AGM statement saw Afren report record revenues of $1.64 billion, which were underpinned by a strong performance from its core Nigerian fields, Ebok and Okoro, and net daily production of more than 47,000 boepd (barrels of oil equivalent per day), at the top end of its guidance range. The company is also enjoyed significant success at the drillbit last year, with a 2P reserves replacement ratio of 201% – including involvement in the third largest discovery anywhere in the world last year, OPL310.

Although there was something of a speedbump in Q1, when production and revenues slipped after a reduction in production share from Ebok following cost recovery, production growth looks set to remain in double digits for the foreseeable future.

Broker Westhouse sees production rising to 47,200 boepd in 2015, then 72,600 boepd in 2016. However, the standout feature is the cashflow per share figure, which Westhouse puts at 61 cents (c.36p) per share for 2016. This means the company should have bags of cash from which it can fund its exploration and development programmes.

Against a current share price of 98.7p, this looks like deep value. With an impressive drilling track record, a growing production base and a portfolio that is of strategic interest, Afren is certainly worth a closer look at current levels.