Friday, March 23, 2018

Dana Gas "Swings" to Profit in 2017

DG Ready for Takeoff The Sky is the Limit

DG announced its FY 2017 results on 15 March.  Net profit was USD 83 million equivalent up from a USD 88 million equivalent loss in 2016. 
Does this mean that DG has turned the proverbial corner and that future results are likely to show similar and perhaps even improved results? 
You might think so reading DG’s earnings press release.   
“The turnaround was led by higher realised liquid prices, higher production in Egypt and tight management of operational expenses. Higher profit was also supported by the successful settlement agreement ('Settlement') with the Kurdistan Regional Government ('KRG'). However, Q4 net profit was impacted by an impairment charge of $34 million (AED 125m) against the UAE Zora asset following the year-end reserve report.”
While admittedly it's too early to state conclusively, as the picture above indicates, AA is not convinced that DG has a smooth flight path to a rosier future. There are some fundamental problems at DG.  It's hard to see these being corrected.  Another cautionary message to the unfortunate existing creditors of DG and to any potential ones.
  1. DG’s 2017 Gross Profit was USD 118 million equivalent compared to 2016’s USD 103.  That’s a USD 15 million turnabout or just under 9% of the USD 171 net change between the two years.  So this led the “turnaround” only in the sense of occurring first in the income statement.  Note: Gross Profit = Gross Revenues –Royalties – Operating Costs and Depletion.   The Gross Operating Margin (GOM) in 2017 was some 26.22% versus a slightly higher percentage in 2016.  GOM = Gross Revenues/Gross Profit. 
  2. The real “turnaround” occurred in other expenses and income which were a net credit of USD 3 million versus a net debit of USD 58 million in 2016. 
Has DG discovered a magic solution to controlling expenses?  Has its business fundamentally changed, leading to new ongoing "other revenue" stream?  Or has it benefited from one-off events?
If you guessed the latter, you’ve guessed right.  References to notes below are to those in the 2017 FY Audited Financials available here. 
  1. DG had USD 26 million in other income (note 7).  Under the agreement with RWE regarding its investment in Pearl Petroleum Ltd, RWE owes DG additional payments when PPL pays a dividend.   PPL paid a dividend as a result of the settlement with the KRG.  Future PPL dividends are likely to be contingent on settlements with Iran’s NIOC.  Probably a low probability event. 
  2. DG benefited from a USD 114 million reversal of Surplus over Entitlement (note 29) again resulting from the settlement with the KRG. 
  3. These two items aggregate some USD 140 million in credits that are unlikely to recur.  Adjusting for these, 2017 results would be a net loss of some USD 57 million.  Income tax expense (note 9) appears related solely to DG’s Egyptian operations and so would not change based on these adjustments. 
  4. One interesting side note – DG appears to have accrued interest on the sukuk at contractual rates for the full year – some USD 67 million.  Though as the Statement of Cash Flows shows the Company only paid total interest of USD 32 million out of the USD 71 million accrued. 
On that basis, DG has not turned the corner. 
  1. With the recorded USD 83 million in 2017 net income, DG earned a whopping 2.9% on equity. More cellar than stellar. 
  2. Assuming 10% is the minimum appropriate rate for the risk of this company (Disclosure: AA thinks it should be higher but doesn’t want to pile on DG) and that other expenses are roughly USD 100 million a year, DG has to earn net operating revenues of USD 382 million. If ongoing other revenue streams of this magnitude are not likely, then DG has to increase its net operating profit.
  3. Assuming the 26% GOM would hold (and it probably wouldn’t given higher production), DG would have earn gross revenues of roughly USD 1.469 billion or 3.3x 2017 gross revenues. 
  4. Alternatively, without a change in gross revenue, DG’s GOM would have to be roughly 85% which is almost certain not to happen.  If gross revenues were doubled, the GOM would have to reach 42% - another level that seems less than attainable.
Other Information in DG’s Financials
What else did we learn from DG’s FY 2017 annual report? 
  1. Of the USD 1 billion KRG settlement, DG received USD 350 million of which USD 140 million is restricted for investments to increase production in the KRI. DG is able to utilize that amount for other purposes if it can raise financing.  Imprudent or uninformed is the financial institution that would lend to this discredited (that’s a partial pun) borrower for a venture in what might charitably be described as a squirrelly market.
  2. Some (a) USD 695 million in be-whiskered KRG trade receivables and (b) interest due on them which had been deducted from Surplus over Entitlement have been “discharged”.  The KRG no longer is legally obliged to unconditionally pay these amounts.  Rather they have been transformed into additions to “petroleum cost” carried under “property, plant, and equipment”.  Under its concession agreement with the KRG, PPL has the right to recover certain costs of investment in the KRG from future production. If there is insufficient future production or none at all, the amount is lost.  If recovery of these costs requires an extended period, then the present value of the amounts recovered will be less than the amounts booked.  And it appears that unlike the trade receivables, PPL and thus DG have no right to interest on the unpaid amount.  In short, as part of the settlement PPL has transformed a sum certain debt payment into a contingent payment the amount and timing of which is uncertain with no protection by way of interest accrual.  On the other hand, as a practical matter this may have been the only way to “collect” this debt. 
  3. The woes at Zora continue.  2017 production is 39% down from 2016.  The Company also assesses that “At present it is unlikely that further well interventions can be economically justified …” Financials page 5. 

Quibbles
As usual with AA, he just can’t resist a technical quibble.  Or two. 
  1. In its FYE 2017 Financials, DG observes that its 2017 net income of USD 83 million represents a 194% turnaround from the 2016 loss of USD 88 million.  That’s an interesting calculation.  If, for example, DG earned USD 1 million in 2016 and USD 83 million in 2017, then the net change would have been an impressive 82 times or 8200%.  But going from a loss of USD 88 million in 2016 to USD 83 million in 2017 is only 194%!  Trust this is an outlier error in DG's financial calculations.
  2. In commenting on DG’s 2017 results AA’s favorite GCC financial newspaper apparently misread the quote above from DG’s press release causing GN to say that “Revenues of the company went up to $450 million in 2017, from $392 million a year earlier due to higher oil prices, increase in production in Egypt and tight management of operational expenses, the company said on Thursday.”   DG’s quote referred to net income not gross revenues which are before any expenses.


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