Ticker: HBR LN
Mkt Cap: £1,872mn
I opened a new position on 24 August (1.5% weight), but having done some additional analysis over the weekend, I decided to exit it next week. Probably the most speculative action I have taken in many years.
Harbour is the largest independent UK offshore E&P company with c. 190kboe/d production and 2P reserves of 410mn boe (+455mn boe of 2C resources). Its production is roughly equally split between gas and oil. The company has a reasonable cost structure with lifting costs at $16/boe and less than $30/boe total costs, including development and decommissioning capex (excluding exploration).
The company has reduced its net debt by $2.9bn since Q1 ’21, when it completed the acquisition of Premier Oil to zero by 1H23. Management guides for $0.2bn Net Debt by the end of ’23 (due to cyclical pickup in capex during H2, higher tax payments and working capital reversal). This estimate does not include proceeds from the sale of the Vietnam assets ($84mn), expected before the year-end.
At 190kboe/d production and $80/bl and 100p/therm (NBP gas price), the company should generate $3.7bn operating cash flow before taxes. With capex at $1bn, Harbour can generate $2.0-2.7bn of FCF pre-tax.
Fiscal payments are the most critical item. Following tax hikes introduced by the UK government last year, the effective tax rate for the sector has increased to 75% (from 40%). This windfall tax is scheduled for five years (until March 2028). Investment allowances can reduce effective tax liabilities. Initially set at 80% (in May 2022), they were later reduced to just 29%. However, decarbonisation expenditure enjoys an 80% investment allowance. So companies, for example, can claim 80% of the costs to modify an oil platform to use wind power.
In June 2023, the government introduced additional changes reducing companies’ tax liabilities if energy prices fall. Specifically, the tax rate will return to 40% if both oil and gas prices average $71.4/bl and £0.54/therm for two consecutive quarters.
For 2023, Harbour guides for $1bn of FCF (after-tax), assuming $80/bl oil price and £1.0/therm gas price ($12.5/mmbtu). The company also plans to spend $1bn on capex (60% on production & development and 40% equally split between exploration and decommissioning). This suggests that management expects c. $2bn of operating cash flow after tax in 2023.
In H1 ’23, it already generated $1bn of FCF but paid zero taxes, and its capex was $434mn (43% of the annual target). For the full year, management expects over $400mn of tax payments and $1bn capex, implying $1bn of outflows on taxes and capex in the second half of the year and zero FCF.
However, at a 75% tax rate, I estimate the company should generate around $1bn of operating cash flow on a normalised basis (at spot prices), which leaves FCF at zero if capex remains at $1bn. Of course, working capital movements and timing of tax payments may temporarily boost FCF. Harbour had $1,097mn tax losses and allowances at the end of H1 ’23. This should help the company reduce its near-term tax liability and generate better FCF.
The company also has about 260mn 2C resources outside the UK, primarily in Indonesia and Mexico. They can potentially be brought into production in the medium term, reducing the company’s effective tax rate.
The company estimates that its FCF has the following sensitivity to energy prices:
- A $5/bbl change in 2023 Brent impacts 2023 FCF by $90m
- A 10p/therm change in 2023 NBP impacts 2023 FCF by $50m
Apart from the extreme tax burden in the UK and increased uncertainty over future unit economics of the core assets, another serious issue is the short reserves life. Daily production of 190kboe/d translates into annual output of 69mn boe. With 410mn boe of 2P reserves, Harbour’s reserves life is just 5.9. Unless new assets are launched into production soon, its current output will fall quite significantly (by 15-20%) and will remain on a declining trajectory without new discoveries or M&A deals.
Insiders were mostly net sellers in the company, and there is no high ownership by management or Board members.
Management targets $200mn annual dividend distributions with plans to increase these distributions regularly. On top of this, the company carries out a buyback programme using surplus cash resources.
The company repurchased 64mn shares (£166mn) since the start of the year, reducing the share count by 7.4%. In 2022, Harbour spent $361mn on buyback. It has returned $1bn to shareholders in the past 18 months (dividends + buyback) in addition to a $2.9bn reduction of net debt.
Having done an additional analysis of the company’s H1 ’23 results and taking into account that without additional allowances, the company hardly earns sustainable FCF, I decided to exit my small speculative position, which I opened on Thursday (24 August).