Why investors are bullish on Seplat

It’s not yet 100% certain that we will end up in a global economic recession. However, investors are beyond spooked seeing how financial markets and companies are reacting.

One of our recent stories showed how tech layoffs are getting close to pandemic levels, with companies like Peloton and Better.com letting go of thousands of employees. The rationale is simple—the threat of a recession means revenue growth is slowing down, and tech companies need to cut down costs to survive.

But while the digital economy is bracing for an economic slowdown, the oil and gas sector is booming. 

You see, prices of oil and gas-related commodities like crude oil, diesel, jet fuel, petrol and natural gas have been soaring this year and show no indication of slowing down. However, this oil and gas price revival was inevitable. During the pandemic, the oil and gas sector suffered significant losses following lockdown measures that plunged demand to practically zero. So, as the global economy opened back up, oil producers were slow to restore supply to pre-pandemic levels just in case the world went back into lockdown. This is why oil prices were high at over $80/barrel even before Russia invaded Ukraine.

But the invasion happened, and with Russia being one of the top three oil and gas producing countries, prices exceeded $100/barrel. Since then, oil prices have stayed high. In Q1 2022, Shell and Exxon Mobil made about $9 billion, 3x Q1 2021 profits. BP also made $6 billion in Q1 2022 profits, its highest in ten years.

As we’ve been saying, it’s a great time to be an oil and gas producer or, at the very least, to be affiliated with one. For Nigeria, our government isn’t benefitting from the oil price boom because our production levels are low and petrol subsidy payments are sky-high. But, Nigeria’s number one indigenous oil and gas company, Seplat, is benefitting. In Q1 2022, Seplat recorded a 58.6% increase in revenues and a 130% increase in operating profit despite lower production volumes.

So, as the economic downturn and oil price boom continue, you need to keep your friends close and your Seplat shareholder friends even closer. We’re going to explore why in this article.

The typical NGX investor

Within the past week, the top 10 companies on the S&P 500 (the 500 largest companies in the US) have lost over $1 trillion. As of May, the US stock market had lost $7 trillion.

In comparison, NGX's market cap is less than ₦30 trillion, barely $70 billion. So, no, the Nigerian stock exchange doesn’t immediately come to mind when we think about the global financial market.

However, even the NGX has its darlings. Think MTN, Dangote and now, Seplat. Every typical stock market investor wants a piece of these MVPs because of their high growth potential. I say typical here because some investors aren’t solely interested in financial returns. For example, impact investors (like climate change activists) are also interested in companies that create a positive social or environmental impact.

Following extensive research on investing principles, there are three primary criteria to consider to determine whether a company has high growth potential. These criteria are based on financial investing principles that determine whether the company’s business model and financials are solid. Essentially, you follow the money to see whether the company’s primary revenue stream is profitable.

Second, investors look out for companies' adherence to corporate governance codes and engagement with stakeholders such as employees, customers, community and shareholders. Corporate governance codes are rules and procedures for managing an organisation to ensure stakeholders' objectives are met. This entails a lot of transparency, so stakeholders know what’s happening in the company. Shareholders interested in financial returns (dividends) can be rest assured that the company’s management is focused on maximising profits and shunning illegal or unethical behaviour. The only way to get this assurance is through regular disclosures from the company.

Finally, investors want companies that can adapt and grow. The world is fast-paced thanks to technology and innovation within the past decade, and companies need to adapt. For instance, in telecomms, from when MTN came into Nigeria till now, the technology has evolved from 2G to 5G cellular networks. The same innovation applies to other sectors, and companies that stand the test of time are companies that adapt to technology. This could also be seen as how well companies can maintain their competitive advantage in a constantly evolving world.

These three criteria—business model and financials, corporate governance, and adaptability—are essential for investors when deciding what companies to put their money in. These criteria are everything for Nigerian investors holding a currency that loses half its value every six years and a limited financial market.

How does Seplat hold up to the typical Nigerian investor’s litmus test? First, the financials.
 

How Seplat makes money

Seplat is an oil and gas company that explores and drills for crude oil and natural gas, which it sells to earn revenue. Oil and gas revenues are determined by the commodities’ price and quantity. Essentially, the higher the crude oil price and quantity, the higher the revenue. So, let’s look at quantity and price individually.

In Q1 2022, Seplat’s average production was 47,603 barrels of oil equivalent per day (boepd). In comparison, Q1 2021 was 48,240 boepd, a 1.3% reduction.

A detailed breakdown shows that some Oil Mining Leases (OML) performed better than others. An OML grants a company exclusive rights to explore, produce and evacuate oil and gas from a specific site. OML 40 recorded a 105% increase from Q1 2021, but Seplat’s major producing assets, OMLs 4, 38 and 41, recorded an 8% decrease. In addition, the Ubima asset only produced 337 bpd in 2021 and recorded zero production in Q1 2022.

Operations in Nigeria’s upstream sector are wrought with challenges of vandalism and theft that have plagued the Niger Delta for decades. Sadly, higher than planned downtimes on the Trans Forcados System, the second-largest pipeline network in the Niger Delta, caused Seplat’s lower production from OMLs 4, 38 and 41. Shell operates the pipeline, transporting over 200,000 bpd for companies, including Seplat. Pipelines have planned downtimes which are required for maintenance purposes at specific periods. However, vandalism and leaks caused this downtime to be 18% higher than planned in the year's first three months. Seplat also mentions Ubima in Rivers state as a high operating cost environment due to vandalism and theft, which require significant capital expenditure to find more safe evacuation routes.

But Seplat is trying to find ways around Nigeria’s high-cost operating environment. For the Trans Forcados system, Seplat intends to use another pipeline network operated by Chevron called the Amukpe-Forcados system starting Q3 2022. And for Ubima, Seplat has decided to divest from the region entirely, given its marginal impact on Seplat’s oil and gas reserves.

In terms of pricing, we’ve already covered that oil and gas prices this year are much better than last year. The average oil price in Q1 2022 for Seplat was $97/barrel compared to $60/barrel in 2021, a 60% increase. This significant spike in prices combined with marginally lower production volumes explains the financials Seplat delivered in Q1 2022.

The company recorded a revenue of ₦100 billion in Q1 alone compared to about ₦58 billion in the same quarter the previous year. This is unprecedented compared to pre-pandemic revenue levels of ₦42 billion and ₦49 billion in Q1 2020 and 2019, respectively.

Meanwhile, Seplat’s costs increased from ₦38 billion to ₦52 billion, mostly due to higher royalty payments. Gross and operating profits increased by 143% and 152%, respectively. But profits after tax were reduced by 12% between Q1 2022 and Q1 2021 due to a 76% tax rate caused by deferred taxes. Essentially, Seplat’s tax for the period was ₦6 billion. But Seplat owed ₦18.9 billion in taxes from previous periods, which they decided to pay in this period. Still, an interim dividend payment of $0.025 per share was approved for Q1 2022.

In a nutshell, Seplat is earning money from its core oil and gas production operation.  Shareholders also earn quarterly dividends and are not exposed to FX risks, given that oil and gas commodities are traded in dollars. Let’s assume that in 2016, a foreign investor exchanged $10,000 for naira to buy ₦3 million shares in a Nigerian company that earns revenue in naira. Given how the naira has depreciated, their investment would need to have increased to at least ₦4.6 million, a 50% value increase, at official rates for them to get their $10,000 back in 2022. And even then, with Nigeria’s scarce FX, it would take a while to get it back. But, Seplat is listed on the London stock exchange (LSE) and the NGX, and shares are fungible. This means a foreign investor from South Africa could buy Seplat shares on the NGX and sell them on the LSE, protecting them from local issues like FX backlogs that affect other investors.

Even compared to other companies in the oil and gas space, Seplat’s financial performance is laudable. As we saw in the third chart in this story, Seplat’s share price is one of the highest in the market and has risen by 98% from the beginning of the year to date.

So far, we’ve covered Seplat’s business model and financials. Next, we need to consider its corporate governance adherence.
 

Corporate governance

Practically, corporate governance means that a company’s board of directors must ensure that the company has rules to ensure profitability and strong ethical values and integrity.

For oil and gas companies operating in a world where their activities are the leading contributor to climate change, it’s tricky to adhere to corporate governance policies. For instance, it seems ironic for an oil company to have values that emphasise safety and environmental preservation when its activities cause oil spills and environmental degradation.

However, Seplat tries to maintain this balance, especially compared to other indigenous oil companies. For instance, Seplat tries to contain spills and leaks while ensuring minimal environmental damage.  Between 2006 and 2021, Seplat spilt 1,500 barrels compared to Aiteo’s 17,800. The company is also transparent about how it achieves sustainability and social impact goals in its annual sustainability report. Globally, leading corporations are linking sustainability goals to the UN’s 17 sustainable development goals based on their areas of operation. Seplat claims to be active in 13 out of 17 goals and has condensed them into a five-pillar framework that comprises education, health and safety, economic empowerment, community infrastructure development and environmental stewardship. For instance, the company claims that $7.4 million was invested in community infrastructure development. It also ranks 83 out of 253 oil and gas companies in terms of ESG risk, which measures everything from climate change mitigation to corruption. For context, Shell ranks 46, while Chevron ranks 104.

But, perhaps the company’s most outstanding achievement in its sustainability journey is how it positioned itself for the renewable energy future.
 

Adapting for the future

All the leading oil and gas companies worldwide have been undergoing a gradual rebrand. Total became TotalEnergies, Saudi Aramco has started making green hydrogen investments, and Seplat refused to be left behind.

Last year, the company rebranded to Seplat Energy to reflect its new mission and business model incorporating the energy transition. We don’t know how long the oil boom will last but to avert climate change and position for the future, companies must start investing in clean energy.

For oil and gas companies like Seplat, it’s a matter of survival. No oil and gas company wants to find itself in a world where oil and gas demand and supply have been replaced by renewable energy—at least not without being a part of the change. So, most companies are currently playing both sides.

Saudi Aramco, the world’s largest oil and gas company, intends to invest $50 billion this year to increase crude oil production to 13 million bpd in 2027 and gas production by 50% by 2030. But, the same company pledged $900 million to develop a 1,500 MW solar power plant in the country. TotalEnergies which has a presence in Nigeria also intends to invest $60 billion into renewables in Nigeria.

Seplat is also investing in gas-to-power infrastructure and renewables. The company says its ANOH gas processing plant, worth $650 million, is 85% complete. The plant will increase gas supplies for electricity and produce liquified petroleum gas (LPG) for cooking.

Without a doubt, Seplat is one of Nigeria’s best-performing companies. As we’ve seen, its business model, corporate governance policy adherence and innovation have set it apart from other companies operating in Nigeria.

But, Seplat is still a company operating in Nigeria—a country where ease of doing business is practically non-existent. While big companies like Seplat can operate around the challenges, they are in no way immune. 

Seplat’s Nigerian breakfast

Earlier, we talked about how vandalism and theft impacted Seplat’s revenues. As we saw, Seplat’s higher revenues are only because of higher-than-normal oil prices. Their production volumes from their highest producing oil assets were sub-optimal due to shutdowns to their major pipeline network. Furthermore, they’ve had to sell off their Ubima site because operating costs are too high. This is the reality of operating in Nigeria’s upstream oil sector—vandalism and theft are actively hurting the operating companies. It’s just that the high oil prices we’re seeing right now are camouflaging the effects of the operating risks. That’s why international oil companies like Shell, Chevron, and ExxonMobil are exiting even with high oil prices.

So, what happens for Seplat when oil prices get back to normal (however long this takes)? 

Well, Seplat is trying to increase its oil and gas production capacity. The company has been trying to secure approvals to acquire Exxon Mobil’s onshore production company MPNU. Unfortunately, getting regulatory approval from the Minister for petroleum has been a big issue. This isn’t a great sign for Seplat investors because the acquisition is significant for the future of Seplat as it will increase the company’s oil production by almost 200%. In its Q1 2022 report, the Seplat CEO assured investors that the deal was still on. Still, the Federal government has declined approvals citing “overriding national interest” as the major reason. It’s not clear how Seplat’s acquisition goes against national interest. However, regulatory and policy issues like this are a major reason why Nigeria’s oil and gas sector (and every other sector) is so unattractive to foreign investment.

For instance, the Petrol Industry Act was passed last year, but implementation has been unbelievably slow and largely ineffective. This slow pace is surprising given that it took 20 years to pass the act and how desperate the sector should be for investment. Oil is a major revenue source for Nigeria, yet production has been dropping so much that the government hasn’t made a kobo from oil since January this year.

Essentially, Seplat’s success, like every other successful Nigerian company, is despite the Nigerian government. You could argue that if Seplat were in another country, they would be doing much better, but so would several companies across various sectors. For Nigerian investors, the options are limited, but it’s clear why Seplat is one of the NGX’s superstars.