HomeMost PopularKosmos Energy: The Underwater Underdog Rising

Kosmos Energy: The Underwater Underdog Rising

Actionable Trade Ideas

always free

When you think of major players in the oil industry, names like Exxon Mobil (XOM) and Chevron (CVX) come to mind. These companies dominate the energy sector with their expansive global operations. Then there are giants like ConocoPhillips (COP) with their diverse portfolio of onshore and offshore assets, and even smaller exploration and production companies like Diamondback Energy (FANG) that focus on extracting oil from US shale plays. But you rarely hear about a company that primarily operates in the deep underwater space. Enter Kosmos Energy (NYSE:KOS). While they have been viewed as an underdog, things are changing, and Kosmos seems poised for success with expected improvements in earnings and free cash flow driven by rising production, higher oil prices, and the completion of major projects. I believe this stock deserves attention in the financial news.

An Offshore Oil Company with a Unique Focus

Kosmos Energy is an independent exploration and production (E&P) company that specializes in extracting oil and gas from offshore areas, especially the Atlantic Margins. Established in 2003, the company had a vision to tap into the untapped potential of deepwater reserves off the coast of West Africa. In 2007, Kosmos Energy made a significant discovery with the identification of the Jubilee field near the coast of Ghana. This discovery was considered one of the most promising and significant oil finds of its time. In 2015, the company made another notable discovery, the Greater Tortue Ahmeyim field located in the deep sea between Mauritania and Senegal.

In addition to these reserves, Kosmos also holds interests in multiple ventures in the US Gulf of Mexico and offshore projects in Equatorial Guinea. Currently, approximately 60% of the company’s output comes from Ghana, with the US Gulf of Mexico contributing just over a quarter (27% as of Q2-2023), and the remainder coming from Equatorial Guinea.

As shown in the chart, Kosmos Energy’s financial performance, like that of its peers, has been influenced by fluctuations in oil prices. The company experienced losses, particularly in 2020 when oil prices plummeted due to the COVID-19 pandemic. However, with the recovery of oil prices in 2021, Kosmos Energy’s earnings rebounded impressively.

Despite this improvement, Kosmos Energy still has significant debt. While the company has initiated efforts to reduce its overall debt, it has a long way to go to catch up with its industry peers.

As of the end of the second quarter, Kosmos Energy reported a debt of $2.41 billion and cash reserves of $89.1 million. This results in a net debt of approximately $2.32 billion, a slight decrease from its peak of $2.50 billion at the end of 2021. However, for a company valued at $3.3 billion, this debt burden is quite high and translates to a debt-to-equity ratio of 266%.

In contrast, other major players in the oil industry such as Exxon Mobil, Chevron, ConocoPhillips, and EOG Resources (EOG) have successfully reduced their debt burdens over the past few years. These companies have utilized their robust profits and ample free cash flow to strategically pay down debt. Currently, their debt-to-equity ratios, which are among the lowest in the sector, range from 15% to 35%.

Examining Kosmos Energy’s cash flow situation highlights a major concern. The company has struggled to consistently generate positive free cash flow. In the first half of this year, the company had negative free cash flow of $195 million, as cash generated from operations did not cover total capital expenditures. Although there was a positive swing in 2022 with free cash flow of $343 million, the previous year (2021) showed negative free cash flow of $98 million. This inconsistent performance has contributed to the company’s elevated debt levels.

Potential Turnaround: Increasing Production

It is important to note that Kosmos Energy primarily focuses on offshore projects, which are generally more expensive to develop compared to onshore projects. However, once operational, these projects can generate consistent returns over extended periods without significant additional capital investments.

Kosmos Energy has made substantial investments in offshore projects in Ghana, Equatorial Guinea, the Gulf of Mexico, Mauritania, and Senegal. While this investment strategy has impacted free cash flow, it has positioned the company for future success.

In Ghana, Kosmos Energy has been actively developing the Jubilee and TEN fields, which contribute significantly to its overall oil and gas production. The company has a 38.6% stake in Jubilee and a 20.4% interest in TEN, with Tullow Oil (OTCPK:TUWLF) serving as the chief operator in both areas. Kosmos Energy has invested significant capital in these regions to unlock new oil wells and increase production levels. In Q2-2023, the Jubilee field reported a gross production of 82,700 barrels of oil per day (bopd). Two new wells from the Jubilee South East development were brought online in Q3, resulting in gross production figures reaching 100,000 bopd in July. In the current quarter, one new producer well and two injector wells will also be placed into service, further boosting production.

Kosmos Energy projects a Q3 production range of 67,000 to 70,000 barrels of oil equivalent per day (boe/day), representing an 18% increase from Q2 figures, driven by the new Jubilee wells. As the newly operational wells reach their full production potential in Q4, production could potentially exceed 80,000 boe/day and approach 90,000 boe/day. The company’s guidance for FY-2023 is an average production of 67,000 boe/day, suggesting a Q4 production rate around 83,000 boe/day.

As a result, I anticipate Kosmos Energy’s Q4 oil and gas production to surpass Q1 figures by approximately 40%. This surge in production will boost the company’s earnings and cash flow, particularly when combined with favorable oil prices.

Potential Turnaround: Rising Oil Prices

Oil prices have experienced a significant surge in recent months, with both WTI and Brent futures increasing by nearly 30% in the past three months, currently settling at around $90 per barrel. This surge can be attributed to various factors, including supply curtailments by OPEC+, reduced production by US shale oil players, and strong demand primarily from Asia and other key regions.

An important development came from Saudi Arabia and Russia, two prominent OPEC+ producers, who announced that they would extend their collective production cuts of 1.3 million barrels per day (bpd) until the end of 2023. Additionally, Russia implemented provisional measures to restrict diesel and gasoline exports, further tightening global supply. In contrast, the US has taken a more conservative approach to oil production growth. Shale oil producers are prioritizing cash flow generation and shareholder returns over aggressive production growth. According to data from the US EIA, US field crude oil production averaged 12.8 million bpd in June, a slight increase from January’s 12.6 million bpd.

Despite concerns about the global economy, oil demand has remained robust. China, a major crude oil consumer, experienced a slowdown in economic growth following its COVID-19 reopening, prompting government interventions. However, oil demand in China has remained resilient, demonstrated by strong crude oil import metrics and refinery throughput figures. In the past month, China’s crude oil imports increased by nearly 21% compared to July and 31% year-over-year, reaching 52.8 million metric tons. Refinery throughput also reached a record high of 64.69 million metric tons, reflecting the efforts of domestic refining industries to meet both local and international demand.

In my opinion, the supply cuts from OPEC+ and limited growth from the US could result in a significant supply shortage in the fourth quarter, consistent with estimates from the IEA and OPEC. With the onset of winter, oil consumption in the northern hemisphere is expected to increase. Given this tightening supply and strong demand, oil prices are likely to remain elevated, which bodes well for Kosmos Energy.

Earnings & Cash Flow Growth

I anticipate that Kosmos Energy’s financial position will strengthen in the coming months, supported by several factors. Notably, oil prices have increased from $75.32 per barrel in the second quarter to the $90 range. Higher prices, combined with growing production rates, position the company to achieve significant growth in earnings and cash flow.

Another crucial factor to consider is the company’s capital expenditure (CapEx) trajectory. Given the timeline and completion of major projects, particularly the Jubilee project, the second half of 2023 is expected to see a decline in CapEx compared to the first six months of the year. Based on management’s comments and project timelines, it can be projected that Kosmos Energy’s CapEx for Q3 will be approximately equal to the reported $170 million in Q2, potentially increasing to around $179 million in Q4. This sequential increase in Q4 is mainly due to intensified activities in the Gulf of Mexico and the Tortue Subsea project in Mauritania and Senegal. The second half of 2023 is expected to have a total capital outlay of around $349 million, compared to the $376 million in H1-2023.

The combination of reduced capital expenses and increased cash inflows is likely to lead to positive free cash flow for Kosmos Energy in the second half of 2023, signaling a significant financial turnaround. However, the positive outlook for Kosmos Energy extends beyond this initial improvement.

Kosmos Energy has recently started drilling in the Tiberius prospect and plans to begin drilling at the Winterfell project in the ongoing quarter, which is the reason for the increased activity in the Gulf of Mexico. The Tiberius play could hold reserves of 135 million barrels of oil equivalent. More details are expected to be revealed when the company releases its third-quarter results. As for Winterfell, it has the potential to be a 100 million barrel oil equivalent resource with significant upside. Production from Winterfell is scheduled to start in the first quarter of next year. During the same period, the Tortue Ahmeyim LNG project is also expected to achieve first gas. The company and its partners have been working on subsea installations while simultaneously developing the FLNG. Although the Tortue project has experienced some delays, it is currently on track to start up in Q1-2024.

The commencement of these new projects will have two major effects. First, Kosmos Energy’s production is expected to surge in 2024, exceeding the anticipated production of 80,000 boe/day in Q4-2023. This increase will bolster the company’s earnings and cash flow. Second, as more projects start producing, capital expenditures are likely to significantly decrease. This sets the stage for growing cash inflows and reduced capital-related outflows, positioning the company for strong free cash flow generation.

As previously mentioned, one of the challenges Kosmos Energy has faced is its inconsistency in generating significant free cash flow, which has contributed to its significant debt levels. However, it appears that the company is on the verge of a crucial moment. As long-planned projects become operational and with favorable oil prices, Kosmos Energy’s earnings and free cash flow are expected to increase significantly. I believe the company will utilize this surplus cash to reduce its debt. While the company’s debt metrics are currently high, indications suggest that its leverage situation could improve as early as this year. This shift is likely to positively impact the company’s valuation.

Takeaway & Risks

Kosmos Energy is on the path to transformation. The company, which has faced negative free cash flow and substantial debt, now appears poised to improve its financial situation. Several positive factors, including increased production, favorable oil market conditions, and decreasing capital expenditures due to the completion of major projects, are expected to boost profits and free cash flow. I maintain a bullish stance on the stock, as the future looks promising.

From a valuation perspective, the stock is trading at 10.6 times forward earnings, slightly above the industry average of 10.5 times, according to Seeking Alpha data. Seeking Alpha’s valuation grade for the stock is ‘C’, indicating that value-focused investors may want to wait for a potential pullback before considering an investment.

However, investing in Kosmos Energy is not without risks. Like other oil stocks, the company’s stock price is tied to the volatility of oil prices. However, what sets Kosmos apart is its relatively high debt load, which makes it more vulnerable to market downturns. While the potential for upside is significant, investors need to exercise caution. The company’s risk profile, especially its debt situation, makes it a less suitable choice for conservative investors with low-risk tolerance.

Swing Trading Ideas and Market Commentary

Need some new swing ideas? Get free weekly swing ideas and market commentary from Jonathan Bernstein here: Swing Trading.

Explore More

Weekly In-Depth Market Analysis and Actionable Trade Ideas

Get institutional-level analysis and trade ideas to take your trading to the next level, sign up for free and become apart of the community.