The last time I reviewed San Leon Energy (LSE: SLE) at the end of 2016, I concluded that the company’s asset base, desire to return cash to investors and well-funded balance sheet, were all reasons to buy as these factors should drive the shares higher in the long term.
Unfortunately, over the past 12 months, the value of the company’s shares has been cut in half. The big question is now, is the small-cap oil company still an attractive investment?
Making progress
San Leon’s problems stem from issues at its main asset, the OML 18 project in Nigeria. This project, which is operated by regional producer Eroton, has run into several problems over the past 12 months, holding back potential returns to San Leon. Management expects that a large workover project during the fourth quarter should fix the bulk of these issues, paving the way for dividend payments from Eroton.
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The company is already receiving some income from this project via the way of loan notes issued to Midwestern Leon Petroleum Limited. Under the instrument, MLPL is required to make quarterly interest payments on the loan notes, subject to MLPL having received funds derived from OML 18 by way of dividends or distributions from Eroton. Even if no dividends are received, MLPL is still required to pay back the notes after a given period. The company received $20.6m in the third quarter under this agreement. San Leon is scheduled to be repaid approximately $19m per quarter from Q4 2017.
Including these loan notes, all in all, management has “three targeted cash flow streams from Nigeria: Loan Note repayments, dividends from production via the indirect equity interest in OML 18, and from the provision of drilling and workover rig services to Eroton under the Master Services Agreement.“
Dividend income and the repayment of loan notes is just one of the ways San Leon can create value for investors. The firm is also currently in discussions with China Great United Petroleum regarding a possible takeover.
According to the company’s half-year results published today, the parties have been in talks since December 2016, and due diligence is still ongoing. The last time a takeover was pitched, an offer price of £1 per share for San Leon was put forward.
High risk, high reward
San Leon’s outlook has only improved since this time last year, so I believe a target price of £1 per share is still reasonable. Even a target price of 50p indicates an upside of more than 100% from current levels.
That being said, San Leon isn’t entirely risk-free. According to the company’s first-half results, even after receiving the $20.6m loan note payment, on 27 September the firm’s cash balance was a meagre €1.7m.
The sale of a majority stake in the group’s Polish assets should help boost its coffers but two further payments of €8m and €6.7m to Avobone regarding its exit from the Siekierki project in Poland later this year will put more pressure on the balance sheet.
Overall, even though I believe San Leon looks undervalued based on its assets, the company could be heading for a cash crunch in the next few months.
