Leigh Creek Energy — Fully capitalised for pre-commercial demo

Leigh Creek Energy

Fully capitalised for pre-commercial demo

Update

Oil & gas

22 May 2017

Price	A$0.14
Market cap	A$47m
US$0.77/A$
Net cash estimate May 2017 (A$m)		14.0

Basic shares in issue at May 2017		332.4m
Free float	56%
Code	LCK

Primary exchange	ASX
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	(25.0)	(35.7)	(54.2)
Rel (local)	(24.1)	(34.8)	(57.3)

52-week high/low

A$0.3

A$0.1

Business description

Leigh Creek Energy (LCK) has a certified PRMS gas resource of 2,964PJ (2C) at the Leigh Creek Energy Project (LCEP) in South Australia. Monetisation of this gas through ISG is expected to be de-risked by a demonstration programme in late 2017.

Next event

Pre-commercial demo

2017

Analyst

Sanjeev Bahl

+44 (0)20 3077 5700

oilandgas@edisongroup.com

Edison profile page

Leigh Creek Energy is a research client of Edison Investment Research Limited

On 31 March 2017, Leigh Creek Energy (LCK) announced that it had raised A$21.85m of new equity; net proceeds are to be used to fund the company’s pre-commercial ISG demonstration project. A new cornerstone investor has also been added to LCK’s shareholder register, China New Energy, a Hong Kong-based company with a mix of assets in China including steel mills, gas fired power stations and coal mines. Our RENAV falls from $0.31/share to $0.26/share to reflect the equity dilution but importantly, the new funding provides visibility on the upcoming demonstration project which has the potential to significantly de-risk LCK’s flagship project. We continue to risk our valuation with a subjective 20% chance of commercial success – we expect to revise this risking on completion of the demonstration project.

Year end	Revenue (A$m)	PBT* (A$m)	Capex (A$m)	Net cash (A$m)	Free cash flow (A$m)
06/15	0.0	(17.7)	(1.2)	1.4	(2.1)
06/16	0.0	(5.4)	(1.8)	8.7	(5.8)
06/17e	0.0	(2.9)	(0.0)	10.7	(2.0)
06/18e	0.0	(2.9)	(16.0)	7.8	(18.8)

Note: *PBT is normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

China New Energy strategic investment

China New Energy’s (CNE) investment in LCK comes in the form of three tranches: the first (A$4.1m) was settled in Q117, the second (A$3.4m) settled in May 2017 and the third (A$12.5m) is to be issued, subject to shareholder approval, no later than eight weeks after tranche two. On completion of tranche three, CNE will hold 32.78% of the company’s equity and after tranche two will have a right to a seat on the board. Despite the NAV/share dilution, we believe CNE brings much needed capital and power generation expertise to the group enabling LCK to progress the Leigh Creek Energy Project (LCEP) through demonstration in late 2017 / early 2018.

Valuation and sensitivities

Our updated risked valuation of A$0.26/share incorporates LCK’s announced equity injection and associated dilution. We assume commercial demonstration in late 2017/early 2018 and first commercial gas in 2021 (from 2020). Based on our updated valuation, we believe the market is implying a 12% commercial chance of success for LCEP (vs 20% in our model). Key project sensitivities include the timing of relevant permits and approvals for demonstration and full field commercialisation and LCK’s ability to attract capital/farm-out the upstream development and to attract power/pipeline partners for mid-stream elements of the project. For a full breakdown of modelled assumptions and gross project economics investors should refer to Edison’s initiation report dated February 2017.

Pre-commercial demonstration funded

LCK has raised a total of gross A$21.85m with proceeds to be used to fund the completion of the company’s ISG demonstration facility. Equity was placed with professional investors, with the largest component going to a new strategic investor, China New Energy.

China New Energy (CNE) is a Hong Kong-based company with significant assets in China as joint owner with Shanxi Meijin Energy of the following assets:

■

Steel Mills producing 2mt per annum of steel

■

three gas fired power stations

■

four coking coal and PCI mines

China New Energy funding consists of a three-stage placement of 150m shares in LCK at an average price of A14.6c, raising a total of A$21.85m.

■

Tranche 1: Issue of 30m shares at A$0.135/share raising A$4.1m settled in Q117.

■

Tranche 2: Issue of 22.8m shares at A$0.15/share raising A$3.4m settled in May 2017.

■

Tranche 3: Issue of 83.5m shares at A$0.15/share raising A$12.5m.

On completion of the second tranche funding CNE will have the right to a seat on the board of directors of LCK and following tranche three, CNE will hold 32.78% of the total LCK shares in issue. In addition to the CNE placement, LCK has raised a further A$1.8m through the placement of 13.7m shares at A$0.135/share with professional investors.

LCK’s equity issue is dilutive to our per share valuation for LCK which had previously assumed debt funding for the company’s ISG demonstration project. However, visibility on funding should provide investors with confidence in the company’s ability to fund a key catalyst with the potential to de-risk the wider full-field development of the Leigh Creek Energy Project (LCEP). Construction contracts for the major components of the demonstration project have been awarded.

Macro developments

Since our last note on Leigh Creek Energy there have been a number of significant developments in the South Australian (SA) power market. Jay Weatherill, the Premier of South Australia, has been vocal of the state’s need for greater energy security, price control and energy independence. In March 2017, SA unveiled a new energy plan aimed at delivering more generating capacity, greater competition, increased public ownership of assets, more renewable energy with battery storage, more gas supplies and job opportunities in SA. The plan includes six key components summarised below. The key element of the plan relevant for LCK is the state’s goal to increase in state gas-powered generation capacity and to provide incentives to domestic, within state gas producers.

■

Battery storage and renewable technology fund: State government to establish a $150m fund to support projects that make renewable energy available 24 hours a day, seven days a week. The first project to be funded is to be a grid-connected battery to provide 100MW of storage.

■

New gas power plant: The state government will build its own gas-fired electricity generator to provide up to 250MW of emergency generation.

■

Local powers over national market: the state government is to legislate to ensure that South Australian energy users are not held hostage to unwarranted market behaviour. This includes the ability to direct generators to operate and the Australian Energy Market Operator to control flow on the interconnector.

■

Energy security target: A new target will require energy retailers to get more electricity from clean generators that utilise SA abundant natural resources. Generators will be compelled to source a percentage of energy from local generators rather than from inter-state interconnectors.

■

South Australian gas incentives: To meet increasing levels of gas-fired generation, the state government is to provide an extra $24m for a second round of Plan for Accelerating Exploration (PACE) funding. This is expected to increase the supply of South Australian gas into the local energy market. This includes a 10% royalty for landowners in order to incentivise development of natural resources.

■

New generation for more competition: New generation capacity within state is expected to increase competition and put downward pressure on prices.

Overall, we believe the outlined energy plan to be a positive for LCK, with an increased focus on development of SA’s gas resource. LCK will need to demonstrate that the company can extract gas commercially and in an environmentally sensitive manner in order to meet the SA’s aim to increase within state clean gas power generation.

Valuation

Core elements of our valuation of LCK are provided in our initiation note (2 February 2017). In this note, we update our valuation to reflect equity funding for the company’s ISG demonstration project and a delay of LCEP first gas to 2021 (compared to 2020), offset by a roll-forward of our NAV discount date from 2016 to 2017. We had previously assumed that the demonstration stage of the LCEP development would be debt funded rather than equity funded. The net impact of this change is dilution of our per share risked valuation from A$0.31/share to A$0.26/share. We flag that this is based on a subjective 20% chance of commercial success and assumed farm-out of the upstream full field development. Further details of gross project economics and farm-out assumptions can be found in our initiation note.

Exhibit 1: LCK valuation – farm-out of upstream: Base case

Asset	Country	Diluted WI	CoS	Recoverable reserves		NPV/GJ	Net risked	Value per share	Discount rate
		Diluted WI	CoS	Gross	Net	value	risked	10%	15%
		%	%	PJ	PJ	A$/GJ	A$m	A$/share	A$/share	A$/share
Net cash end 2018 after demonstration spend		100%	100%				8	0.02	0.02	0.02
SG&A – NPV10 of two years		100%	100%				(7)	(0.02)	(0.02)	(0.02)
Tax rebate		100%	100%				7	0.02	0.02	0.02
Development
LCEP	Australia	31%	20%	2,955.3	916.1	0.52*	95	0.24	0.33	0.17

Core NAV							103	0.26	0.35	0.19

RENAV							103	0.26	0.35	0.19

Source: Edison Investment Research. Note: *Derived from LCEP DCF valuation including the positive value impact of cost carry.

A sensitivity to our chance of success assumption (20% base case) is provided below. The market implied chance of success, post equity dilution, currently stands at 12%.

Exhibit 2: RENAV sensitivity to commercial chance of success % (post farm-down)

Source: Edison Investment Research

In addition, we recognise that there will be several phases of de-risking as the LCEP project progresses through successful demonstration, full appraisal, environmental permitting, full-field development funding and partner alignment. We attempt to demonstrate this de-risking and the potential impact on valuation in Exhibit 3 below.

Exhibit 3: Potential de-risking impacts on RENAV (post farm-down)

Source: Edison Investment Research

At the current share price, LCK offers investors an option on realising value from ISG in South Australia. LCEP has what appears to be an optimal site for an ISG project in a state with a need for additional baseload power capacity. The project does not come without technical and commercial risks; however, we expect technical and environmental aspects to be materially de-risked through the company’s upcoming pilot programme in 2017.

Financials

The remaining net cost of LCK’s ISG demonstration project including operational spend is estimated at c A$16m and is expected to be funded through the company’s recently announced equity funding round of gross proceeds of A$21.85m. In addition to this, LCK has the potential to leverage project partners with which it has existing relationships in order to provide short-term funding.

Our LCK financial forecasts do not reflect LCEP first gas until our modelled start-up date of early 2021; however, we see potential for this to slip as the first gas from demonstration is now expected by end 2017. In our base case forecasts below we assume LCK is cost-carried for its portion of LCEP capex costs prior to first gas, hence there is minimal capex beyond 2018 in our financial forecasts.

Exhibit 4: Financial summary

	A$m	2016	2017e	2018e	2019e	2020e	2021e	2022e
June		IFRS	IFRS	IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		0.0	0.0	0.0	0.0	0.0	12.3	25.2
Cost of Sales		0.0	0.0	0.0	0.0	0.0	(1.1)	(2.2)
Gross Profit		0.0	0.0	0.0	0.0	0.0	11.2	22.9
EBITDA		(5.4)	(3.0)	(3.0)	(3.0)	(3.0)	8.2	19.9
Operating Profit (before amort. and except.)		(5.4)	(3.0)	(3.0)	(3.0)	(3.0)	8.2	19.9
Intangible Amortisation		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Exceptionals		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Other		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Operating Profit		(5.4)	(3.0)	(3.0)	(3.0)	(3.0)	8.2	19.9
Net Interest		(0.0)	0.1	0.1	0.1	0.1	0.1	0.2
Profit Before Tax (norm)		(5.4)	(2.9)	(2.9)	(2.9)	(2.9)	8.3	20.1
Profit Before Tax (FRS 3)		(5.4)	(2.9)	(2.9)	(2.9)	(2.9)	8.3	20.1
Tax		0.0	0.8	0.0	7.2	0.0	(2.1)	(5.6)
Profit After Tax (norm)		(5.4)	(2.1)	(2.9)	4.3	(2.9)	6.2	14.5
Profit After Tax (FRS 3)		(5.4)	(2.1)	(2.9)	4.3	(2.9)	6.2	14.5

Average Number of Shares Outstanding (m)		266.0	296.4	402.4	402.4	402.4	402.4	402.4
EPS - normalised (c)		(2.0)	(0.7)	(0.7)	1.1	(0.7)	1.5	3.6
EPS - normalised and fully diluted (c)		(2.0)	(0.7)	(0.7)	1.1	(0.7)	1.5	3.6
EPS - (IFRS) (c)		(2.0)	(0.7)	(0.7)	1.1	(0.7)	1.5	3.6
Dividend per share (c)		0.0	0.0	0.0	0.0	0.0	0.0	0.0


BALANCE SHEET
Fixed Assets		2.6	2.6	18.6	18.6	18.6	18.6	18.6
Intangible Assets		2.5	2.5	2.5	2.5	2.5	2.5	2.5
Tangible Assets		0.1	0.1	16.1	16.1	16.1	16.1	16.1
Investments		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Current Assets		9.0	11.1	8.2	12.6	9.8	16.0	30.6
Stocks		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Debtors		0.3	0.3	0.3	0.3	0.3	0.3	0.3
Cash		8.7	10.7	7.8	12.2	9.4	15.7	30.2
Other		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Current Liabilities		(0.8)	(0.8)	(0.8)	(0.8)	(0.8)	(0.8)	(0.8)
Creditors		(0.8)	(0.8)	(0.8)	(0.8)	(0.8)	(0.8)	(0.8)
Short term borrowings		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Long Term Liabilities		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Long term borrowings		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Other long term liabilities		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Net Assets		10.8	12.9	26.0	30.3	27.5	33.8	48.3

CASH FLOW
Operating Cash Flow		(4.0)	(2.0)	(2.8)	4.4	(2.8)	6.3	14.5
Net Interest		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Tax		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Capex		(1.8)	0.0	(16.0)	0.0	0.0	0.0	0.0
Acquisitions/disposals		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Financing		13.1	4.1	15.9	0.0	0.0	0.0	0.0
Dividends		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Net Cash Flow		7.3	2.1	(2.9)	4.4	(2.8)	6.3	14.5
Opening net debt/(cash)		(1.4)	(8.7)	(10.7)	(7.8)	(12.2)	(9.4)	(15.7)
HP finance leases initiated		0.0	0.0	0.0	0.0	0.0	0.0	0.0
Other		0.0	0.0	0.0	0.0	(0.0)	0.0	0.0
Closing net debt/(cash)		(8.7)	(10.7)	(7.8)	(12.2)	(9.4)	(15.7)	(30.2)

Source: Edison Investment Research, Leigh Creek Energy. Note: *Capex beyond 2018 funded through assumed farm-down. **R&D tax rebate.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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