crets

Later today I will be sharing what I believe is one of my best investments in all my years in the markets. Doesn't get affected by wars, economy, demand increasing - lack of supply. HUGE tailwinds... strong insider buying....

$KOS Kosmos reported very solid results last week, but the stock dropped that day and has since trended downward in line with the sector, driven mainly by oil prices rather than earnings. Despite the strong performance so far this year, I believe the market is not fully recognizing the significant turnaround. This is understandable, since the stock still screens poorly, as the P&L and balance sheet are lagging, but substantial profits and major improvements in the balance sheet are expected in the coming quarters. I saw some brokers arguing that results were a tad weak because the stock traded lower in the premarket due to headlines about an earnings miss and muted FCF, but this is quite unfair, as the miss was mainly caused by underlift (cargo timings), price realizations, and hedge losses, which somewhat distorted the full picture. After analyzing the earnings, speaking with the company, and fine-tuning the model, here is my perspective: 1. Production reached all-time highs and was near the upper end of the range. This is likely the first time in a long while that the assets have performed so well. GTA is exceeding its nameplate, GoA is performing okay, and Ghana is booming, with Jubilee surpassing all expectations. The company faced significant challenges over the past two years, mainly due to the underperformance of GTA and Jubilee, but those issues are now resolved. The delays and cost overruns associated with GTA are now a thing of the past. The field is expected to continue producing for at least the next 30 years, with production anticipated to increase soon. It was a pleasant surprise to learn that Phase 1+ is progressing faster than I expected, as local governments aim to secure their gas supply. This is crucial because it will boost production without additional costs or capex, resulting in higher FCF. Additionally, the first gas production will initiate the repayment of receivables from Mauritania and Senegal, totaling $444 million as per the latest filing. Certainly, nobody considers this or the lawsuit against McDermott. Both could occur as early as 2027 and significantly reduce debt. Jubilee proved that it only needed proper care; the work on the FPSO, seismic surveys, and drilling campaign was very successful. I believe the market's consensus still underestimates the company's potential, driven by operator guidance. Tullow surprised everyone last November by guiding to an average oil production of 60-70k, while Kosmos estimated 70-80k. However, during the last call, Tullow increased its estimate to 70k. This was a positive update, but it is still below the 80k I expect we will average for the year. Why? We saw a notable improvement, with production remaining above 70k in the first quarter despite limited drilling, as the new well was added only at the very end of the quarter. Based on current decline rates, Q2 is also expected to close above 70k. Additionally, three new wells, totaling 20k barrels, are becoming operational, with the first coming online late in Q2 or early Q3. It’s important to note that these wells are somewhat de-risked since they have already been drilled and completion is about to begin, giving the company good visibility on them. I estimate production will reach up to 90k in Q3, then slightly decline until mid-next year, when a new drilling campaign is planned to maintain high production levels. This should be the reason for RBL banks to consider extending the loan for nearly the same amount, despite the loss of one asset as collateral due to the EG sale. I would like to highlight this production improvement because it was the basis of the investment case. Of course, the war helped to accelerate the massive turnaround, but the Kosmos investment case was all about production increases and dramatic cost reductions, driven by GTA and Jubilee. (as it already happened) 2. Price realizations are lagging because of the pricing terms, but this also implies that when oil prices drop, Kosmos will continue selling at high prices. It is well known that GTA production (∼25% of the total production) is sold based on an average oil price over three months, so the full impact won't be visible until Q3. However, in Q2 will see a significant improvement compared to Q1. In GoA (∼25% of the total production), the process is faster since production is sold at a one-month trailing average. Nevertheless, as the Brent price rose sharply by mid-March, the full benefit of this rise wasn't reflected in the quarter. Last, Ghana accounts for 50% of Kosmos production. Ghana cargo prices are typically based on an average over a 5- or 10-day window before or after loading. To be fair, I was expecting better prices coming from this field, but our timing was unfortunate, with only one cargo leaving Ghana early in March. However, in Q2, we anticipate selling 3 to 4 cargoes this quarter at prices significantly above $100. This includes not only the dated Brent (which is considerably higher than the screen Brent) but also a significant premium of $3 to $15, reflecting market risk in the Middle East. Therefore, as you can imagine, price realizations and FCF generation are expected to significantly improve in Q2, with further gains anticipated in Q3 because of increased Jubilee production and reduced hedging. 3. Production was slightly higher than sales for the third consecutive quarter Kosmos has a material underlift position of 1.3 mboe. Some analysts, including me, expected much higher sales this quarter than production, resulting in greater FCF generation. However, this is primarily a matter of cargo timing. One Suezmax (almost 1 mboe) departing on April 1 instead of March 31 changes the quarterly picture but does not affect profits. To be fair, we've been a bit lucky here, as it’s better to resolve this underlift today rather than over the past year. A similar situation occurred with the GTA condensate cargo, which is priced off Brent. BP realized profits from the cargo lifted in February, likely below $70. We and the NOCs will share the profits from the next two condensate cargoes, with one occurring this quarter. Lastly, be aware that Kosmos has identified a cargo in Jubilee scheduled for late June that could spill into Q3. Whether in Q2 or Q3, this issue will be resolved, and the P&L and balance sheet will reflect that. 4. Hedge losses affecting the P&L The company's pre-war hedges are affecting the P&L because they must be marked to current prices. However, Kosmos won’t face losses from these hedges since it owns the cargoes. I was pleasantly surprised to see that Kosmos did not add any extra hedging for 2026 and has begun hedging 2027 with a $70 floor and $90 ceiling. So far, less than 30% of the remaining production (excluding EG, which will be divested in 2 months) has been hedged, with 50% of the hedges in Q2 and the remaining 50% split equally between Q3 and Q4. I thought Kosmos would have been more aggressive about hedging at the start of the conflict, but they accurately assessed the situation and didn't hedge. It seems the market is beginning to share its view. Even if Hormuz reopens immediately, true normalization likely won't occur until 2027, and this doesn’t imply full production will resume. Initial bottlenecks include mine clearance and tanker logistics, followed by upstream production ramp-up, refining activities, and transportation, which will add several weeks. This is without accounting for damage, so full normalization isn't expected soon. Furthermore, this assumes Hormuz reopens— as a reminder, despite market complacency, the strait remains closed. Oil futures are rising daily, even though spot prices stay muted, supporting Kosmos's strategy of rolling over hedges through 2027 within the 70 to 90 range. Conclusion As you can see, I tried to explain that significant profits are expected even if Hormuz reopens tomorrow. However, I understand the market has not fully priced this in, as the company still screens very poorly. This is because a forward-looking perspective is needed, not a backward-looking one. The turnaround is already underway and reflected in record-high production, but, as noted earlier, FCF is lagging, and the balance sheet still doesn’t reflect the new situation. Some brokers and rating agencies have upgraded their views, yet they remain cautious because Kosmos still appears weak in both absolute terms and relative to peers. Net debt stands at around $2.8 billion, down from $3 billion, mainly due to the capital raise. Over the past twelve months, EBITDAX was $0.6 billion, resulting in a net debt to EBITDAX ratio of approximately 4.5x. Investors might perceive this as too risky for an oil company, especially with oil prices above $100, but this data can be misleading and does not fully represent the current situation, as past EBITDAX was influenced by GTA, Jubilee, and low oil prices. Additionally, the Equatorial Guinea sale is expected to be finalized by July. They only require final approval, which shouldn’t cause any delays since it’s a straightforward transaction. Once completed, Kosmos will strengthen its balance sheet with the proceeds and see a net positive effect on the P&L, as those barrels were expensive at the time. Suddenly, the market will recognize that Kosmos operates as a low-cost producer, with significantly reduced OPEX and interest expenses. Kosmos provided 20% debt-reduction guidance, but after examining their assumptions, I believe they are adopting a cautious approach to oil prices, with an estimate around $70 for the coming months. While the future remains uncertain, I see this as unlikely, and I expect the debt reduction to be closer to $800 rather than the $600 guidance. Of course, today's prices do not reflect this massive FCF and balance sheet turnaround! And that’s all before accounting for receivable repayments or proceeds from McDermott litigation. As always, I want to disclose that we own a substantial amount of shares and bonds, and I could be biased/mistaken, so do your own work!