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Kosmos Energy – is it undervalued or overvalued?


Kosmos Energy [LON:KOS] NYSE:KOS, the Dallas-based upstream oil and gas production company with operations in Ghana, Equatorial Guinea and the U.S. Gulf of Mexico, an offshore gas development in Mauritania and Senegal, as well as an exploration play in São Tomé and Príncipe is doing lots of exciting things, and has an historical reputation as an industry pioneer.

With soaring profits across the board for both majors and juniors, Kosmos Energy might be an outlier even amongst this banquet of riches in 2023. The company, which in an industry dominated by global giants, is still small and nimble, and can take on the more speculative exploration plays, but large enough to muscle its way into profitable opportunities.

Sevenfold returns

From the end of the last oil bear, back in the lockdown-era of March 2020 to date, Kosmos has seen its share price appreciate over 700%.

Even in the last year Kosmos shares have gone up near to 75%.

By contrast, BP LON:BP., which reported record profits of GBP23bn for 2022 today (7th February), as energy prices soared after Russia invaded Ukraine, saw its shares rise around 90% from March 2020 but only 0.4% year-to-date.

Oil and Gas – despite the trend towards renewables – seems to be where it’s at right now, and BP’s chief executive, Bernard Looney, announced a strategic overhaul this morning, scaling back on the company’s investment in green technologies and doubling-down on oil & gas exploration and production.

Kosmos isn’t a new kid on the block. It was founded in 2003, originally backed by US private equity firms Warburg Pincus and Blackstone and was no slouch in getting up and running, discovering the Jubilee Oil Field offshore Ghana in 2007 getting the discovery into production three years later.

Platinum Jubilee

Jubilee is a vast deposit of near 1 billion barrels of oil and some 800 billion cubic feet of natural gas and produces over 100,000 barrels of oil a day currently, Jubilee acted as a springboard into other Africa projects, and the first few years of Kosmos in Ghana was chronicled in a documentary film, Big Men in 2014, produced by Hollywood icon Brad Pitt.

The company debuted on the New York Stock Exchange in 2011 and dual-listed in London six years later. Kosmos has followed the tried-and-tested route to riches for junior explorers – find the field and then bring the big boys in to get the product out. It brought Chevron NYSE:CVX to the party in Suriname and then invited Hess NYSE:HES along soon after.

Having made its name in Ghana, Kosmos brought into the TEN (Tweneboa, Enyenra and Ntomme) project, another Ghana offshore field which came into production in 2016.

Never a company to bother about courting a bit of controversy, Kosmos started drilling offshore in Western Sahara in 2014 at a time when it wasn’t clear (and still isn’t) whether the self-declared Sahrawi Arab Democratic Republic or Morocco owned the bit of sea it was working in. The project saw it enter a legal to-and-fro with UN Security Council and blacklisting from the Norwegian State Pension Fund.

Coastal expansion

The company was also operating a bit further down the coast in Mauritania, where it discovered gas at its Tortue-1 and Bir Allah exploration wells in 2015. Carrying on down the Atlantic coast, Kosmos found another gas field offshore Senegal, bringing the aforementioned BP into partnership in both countries. The partnership seemed to be working well and Kosmos found itself collaborating another major in Africa, alongside Shell LON:SHEL in São Tomé and Príncipe.

Kosmos also started operating on the other shore of the ocean, through acquisition of Deep Gulf Energy, which was exploring in the US Gulf of Mexico in August 2018.

Fishing for oil has been a profitable venture for Kosmos so far. Now that incredible share price rise. Some of it can be explained by Kosmos’ relative size to BP, or Chevron. As explained yesterday, smaller companies have a great deal more potential for growth than the larger ones, as they are coming from a lower position and its all upside, can make decisions more rapidly, and their size means that they are flexible and nimble enough to take on the work that their larger peers cannot.

Kosmos is no corner shop, mom and pop business; the firm is worth north of USD5bn, but in the oil and gas sector it’s like comparing a Velociraptor to a Tyrannosaurus Rex (incidentally both Late Cretaceous dinosaurs that were running around at the time when the oil that Kosmos is pulling up today was first laid down).

Lockdown blues

Back in 2020, the prospects for the oil industry were very different. We were – so the narrative stated – going to post-lockdown, live in the countryside, never drive to work and do everything on Zoom. The world would be powered by cheap, renewable energy and former office workers would be living The Good Life like millennial versions of Richard Briers and Felicity Kendal.

Fast forward to 2023, a slew of vaccinations, a war in Europe and a global recession has seen oil and gas the new gold and breathed life back into what was – according to the narrative – a dying industry on its last legs. Back in 2020, Kosmos and its fellow juniors were punished by myopic markets, which couldn’t see the smaller companies making it through lockdown and predicted, like the Velociraptor, they would become curious museum pieces.

Valuable real estate

Subsequently, investors have moved past the sentiment that the likes of Kosmos would go bankrupt, and as oil and gas prices have appreciated, the exploration plays they sit on have become valuable real estate. And as oil prices nosed upwards and spiked in early 2022, the juniors, Kosmos included, have followed the curve.

Now this is great, in hindsight, and throwing a few quid at Kosmos in 2020 would have been a contrarian, but clever play. The company is obviously involved in a lot of very exciting ventures, but Kosmos is tied to the vagaries of the oil price, much more so than BP or Shell or Chevron, which despite Looney’s comments have a longer-term vision and also sell product into homes and businesses and vehicles. You can’t go fill up your car at a Kosmos garage, or cook your dinner on Kosmos gas.

Supply chain

The issue with oil and gas pricing in 2022 was supply chains. There’s a lot of product going around, and new fields are being discovered all the time. The problem last year was getting the product to where it was going to be sold, as most of it (in Europe) quite handily flowed from the Eastern border and Russia. Obviously taking that off the table meant that there was a real pinch point in supply which meant that gas had to be liquefied  and shipped in from other parts of the world.

At some point, possibly in the not-too-distant future, Russia will turn the taps on again, and although the EU might hold its nose in dealings with its Eastern neighbour, it needs the product in the same way that Russia needs Euros and Dollars. At that time, the price will slump.

And that’s a dangerous place for Kosmos. Unless it can unshackle itself from the hard end of pricing, its share price will decline and over the long term the direction of travel is going to be one-way. Prices were already coming off a bit at the start of the year – not that anyone will see it in their energy bills anytime soon – and Kosmos’ share price lost value. In the first quarter 2020 Kosmos lost 80% as consumption fell, and the Dallas-based firm doesn’t own a fleet of vessels and trucks or pipelines like Chevron or BP.

Downside risk

Although Kosmos’ gains have been more-than-eye-catching, 80% is quite a hit for any company or investor to take and the big risk for Kosmos and the other junior explorers is that they are not exposed to the entirely of the O&G value chain, and really the only diversification play they have is geographic – which in some of the markets where they operate is also a tangible risk as operation can be hampered by geopolitical developments and extreme weather.

As the year progresses, the general economy will most likely continue in recession, or at the lest anaemic growth. But as the year and recession bottoms out, energy process will fall and the economy will start recovering. It’s this recovery, which will be good for some sectors of the economy that might hurt Kosmos.

After 700% upside returns, there will be clawback, and investors shouldn’t be looking at returns at that quantum in the future – unless there is another significant geopolitical crisis, like a much more serious repeat of the Arab Spring of 2010 to 2012. The oil industry, and the politicians that have a vested interest in its continued dominance will fight hard to maintain its economic primacy, but in the fullness of time the Big Men will have to move over and give their place at the table to other competitors.

We’re not saying that Kosmos is a bad investment now. The energy story still has a lot of petrol in the tank, but it is important to consider the downside risk with junior explorers.

According to Deshe Analytics in their recent financial report, which was published on 7th November, 2022, Kosmos Energy had several impressive financial metrics that should make them more attractive than their peers going forward.

Their growth and income factors performance indicate that company management is focused on the right targets and executing well. These results led Deshe to believe that there should be significant upside potential for the stock. Therefore, they earned a total score of 80 out of 100 from the analyst, and a ‘BUY’ recommendation from Deshe.

Kosmos opened trading at 601.75p today (7th February), and has offered a year-to-date return of 16.9%, a one-year return of 69% with its shares ranging between 300.2p and 684p over a 52-week period.

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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