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Table of Contents
Section 1 Executive Summary 3
Section 2 Industry Overview 4
Section 3 Company Overview and Positioning 8
Section 4 Valuation Analysis 13
Section 5 Questions 21
2
Executive Summary
The Oil Drilling and Gas Extraction industry will benefit from strong global demand and rising prices despite high exploration risks
Evolution Petroleum Corporation (EPM) possesses a solid asset base with a unique strategy and innovations to pose a competitive advantage
We value the company at about $9.19 per share
We recommend placing Evolution Petroleum Corporation on the Watch List so future analysts can evaluate its changing risks and growth strategies
3
Industry Overview
Section 1
4
Industry Overview
Oil and gas extraction is a mature, stable market in the United States
Trends include rising global demand from emerging economies, increased crude oil output from offshore drilling, increased natural gas production from new fields, and pressures from regulations and alternative energy growth
New technologies have allowed increased exploration of previously unattainable resources
Price volatility and high capital costs continue to threaten smaller industry players
Industry Trends
The oil and gas extraction industry benefits from rising oil and gas prices and strong global demand
Sources: 1. Deutsche Bank Markets Research. “Oil & Gas for Beginners.” 25 January 2013.2. Credit Suisse. Oil & Gas Primer. September 2011. 3. IBISWorld Industry Reports.
Oil Demand Correlation with Real GDP Growth (1969 – 2008)
Industry Composition
The oil and gas drilling and extraction industry is worth $319.5 billion in the United States
Crude oil makes up 58.4% of the market while natural gas represents 41.6%
The United States sends 59% of its oil and gas exports to Canada and 19% to Mexico
Texas, Oklahoma, and Louisiana contain the largest amount of industry output and revenue in the continental United States
59.3%18.6%
11.1%
9.3%
1.0% 0.7%Petroleum refining industry
Natural gas distribution industry
Utilities
Industrial users
Oil exports
Gas exports
U.S. Oil & Gas Drilling and Extraction Market Segmentation
5
Industry Overview
Competitive Landscape
Low concentration due to high geographic dispersion Top four competitors account for 28% of industry
revenue Economies of scale resulting from large oil and gas
deposits help competitors spread high capital costs Largest players practice downstream vertical integration
to guarantee buyers Stringent regulations threaten large and small
competitors and increase capital requirements
Dominant Players in Oil & Gas Drilling and Extraction
Sources: 1. Deutsche Bank Markets Research. “Oil & Gas for Beginners.” 25 January
2013.2. EIA 2014 Report.3. IBISWorld Industry Reports.
8.2%
7.7%
6.1%
5.8%
72.2%
ConocoPhillipsChevron CorporationRoyal Dutch Shell PLCBP PLCOther
U.S. Production of Crude Oil
The oil and gas drilling and extraction industry features regional dispersion and high revenue volatility
Price Determinants
Prices remain volatile due to changes in supply and demand Global economic recovery increases transportation and
industrial energy demands Different grades of oil (heavy, light) typically attract different
prices with lighter oils earning a premium since they are easier to refine
Impurities also affect the price of oil with sweet oils, or those with a low sulfur content, commanding a premium
High barriers to entry result from security and regulation, capital investments, and the high risks associated with exploration
6
Porter’s Five Forces
Sources: 1. Deutsche Bank Markets Research. “Oil & Gas for Beginners.” 25 January
2013.2. EIA 2014 Report.3. IBISWorld Industry Reports.
The oil and gas drilling and extraction industry is attractive with the potential for long-term profitability
Bargaining Power of Buyers
• Few available substitutes
• Price volatility can deter buyers
Bargaining Power of Suppliers
• Low concentration of industry players
• Critical commodity product
Entry of New Competitors
• Economies of scale
• High capital requirements
• Stringent regulations
• High risk and volatility
Rivalry Among Existing
Competitors
• Limited oil fields and gas reserves
• Smaller firms may share buyers
• Larger firms vertically integrate
Threat of Substitutes
• Low use of alternative energies
• Oil and gas serve separate markets
LOW MEDIUM LOW HIGH LOW
7
Company Overview
Section 2
8
Evolution Petroleum Company (EPM) — Company Overview
Firm Overview
EPM is a petroleum company engaged primarily in acquisition, exploitation and development of properties for the production of crude oil and natural gas
Differentiates through innovative proprietary technology, reliance on unconventional drilling techniques, and exploration of previously uneconomical reserves
Management and employees own 21% of shares Market capitalization of $414 million in 2014
Primary Asset Locations
The company has attractive investments and dedicated management that could sustain future growth
MS Lime
Giddings Field
Delhi Field
Customer Relations
EPM sells commodities so purchasers retain little buying power in the long term
Purchaser 2013Plains Marketing L.P. 90.0%Enterprise Crude Oil LLC 4.0%Flint Hills 2.0%DCP Midstream, LP 1.0%Kinder Morgan 1.0%Enervest, LLC 1.0%Orion Exploration Partners, LLC 1.0%
Revenue Growth
9
Evolution Petroleum Corporation (EPM) — Company Overview
Enhanced Oil Recovery
Increase the production and recovery of oil and natural gas
Enhanced Oil Recovery from the Holt Bryant Unit in the Delhi Field in Louisiana
Purchased in 2003 for $2.8 million Operated by Denbury Resources, Inc. Owns 7.4% interest and 23.9% revisionary
interest
EPM earns money through Enhanced Oil Recovery, Bypassed Primary Resources, and Unconventional Development.
Carbon Dioxide Oil Recovery at Delhi Field
Bypassed Primary Resources and Unconventional Development
Focus on horizontal drilling Mississippi Lime, North Central Oklahoma GARP Artificial Lift Technology
10
SWOT AnalysisEvolution Petroleum Corporation’s reliance on innovative technology and alternative production and exploration methods differentiate it from the competition and provide a foundation for future growth.
Sources: 1. Company website.2. EIA 2014 Outlook.
Strengths WeaknessesProprietary GARP Artificial Lift technology and patents Depends on a few large clients
Rich in assets and proved reserves Depends on crude oil for revenues
Generates scalable reserves potential at a low unit cost with long-term growth potential
No presence in growing global markets
Experienced, trained management team with deep experience in innovative oil and gas exploration and production strategies
Relies on third party operators, marketers, and technologies
Royalty and interest contracts reduce risk and increase revenues Light debt use may limit exploration opportunities
Opportunities ThreatsDelhi Field previously produced millions of barrels of oil indicating future success
Exposure to commodity risk stemming from changing world prices of oil and gas
GARP technology provides licensing opportunities Cyclicality of end markets
Increased demand from transportation and industrial sectors Uncertainties inherent in reserve estimations
Cash reserves can help secure future investment opportunities Increased competition from large, vertically-integrated peers
Increased push for domestic energy output could spur demand Price-elastic, highly competitive environment
11
Recent Stock Performance
12
Valuation Analysis
Section 3
13
EPM WACC Calculation
Risk Free Rate 3.50%Beta 1.28MRP 5%CAPM 9.90%
2-Year Return 35.48%Annualized 16.40%Div Yield 3.20%ROE 19.60%
WeightCAPM 9.9% 80%ROE 19.60% 20%Cost of Equity 11.84%
Return on Equity
CAPMWACC
Cost of Equity
Cost of Debt 4.54% (online source)Tax Rate 35.00%After-Tax 2.95%
Cost of PE 8.50% (dividend yield)
WACC 9.84%Premium 0.5%Adj WACC 10.34%
Cost of Debt
Cost of Preferred Equity
WACC
Debt 18%Common Equity 70%Perferred Equity 12%
100%
Captial Structure
14
EPM Discounted Cash Flow Analysis
2014E 2015E 2016E 2017E 2018EEBIT 12,504,025$ 16,526,333$ 21,778,393$ 28,631,191$ 37,567,162$ Tax Expense (4,418,764)$ (5,839,278)$ (7,694,018)$ (10,113,972)$ (13,269,478)$ Depreciation 1,264,843$ 1,373,196$ 1,490,995$ 1,619,013$ 1,758,103$
9,350,104$ 12,060,251$ 15,575,370$ 20,136,232$ 26,055,787$
Change in NWC (322,071)$ (1,169,816)$ (3,268,762)$ (2,885,949)$ (1,979,261)$ CapEx (3,320,192) (3,611,775) (3,926,620) (4,267,272) (4,636,332) FCF 5,707,841$ 7,278,660$ 8,379,988$ 12,983,011$ 19,440,194$
1 2 3 4 5WACC 10.34% Terminal Growth 3.50%
Terminal Value 294,023,795.75
Discounted FCF 5,172,808$ 5,978,061$ 6,237,446$ 8,757,765$ 179,744,183$
Valuation 205,890,264$ Shares Outstanding 28,205,467
Implied Price 7.30$
Discounted Cash Flow Analysis
15
EPM Sensitivity Analysis
7.30$ 2.500% 3.000% 3.500% 4.000% 4.50%8.34% 9.08 9.88 10.85 12.04 13.549.34% 7.56 8.12 8.77 9.54 10.47
10.34% 6.44 6.84 7.30 7.84 8.4711.34% 5.58 5.88 6.22 6.61 7.0612.34% 4.90 5.13 5.39 5.69 6.02
Senstivity Analysis
16
EPM Comparables Analysis
P/E Forward P/E EV/Revenue EV/EBITDA P/BMC/Proved reserves
VOC Energy Trust (NYSE:VOC) 8.59 7.18 8.4 8.56 2.2 0.04 ECA Marcellus Trust I (NYSE:ECT) 5.33 6.56 6.6 5.27 0.67 - Cross Timbers Royalty Trust (NYSE:CRT) 13.5 - 13.0 13.38 15.9 0.08 Enduro Royalty Trust (NYSE:NDRO) 8.59 10.1 8.5 8.60 0.73 0.02 Hugoton Royalty Trust (NYSE:HGT) 9.34 8.23 8.5 8.83 3.21 0.09 Synergy Resources Corporation (AMEX:SYRG) 51.5 20.9 13.9 34.99 3.32 0.12
Evolution Petroleum Corp. (AMEX:EPM) 105.3 19.7 18.9 39.52 7.31 0.03
Average 16.14 10.59 9.8 13.27 4.34 0.06 Median 8.97 8.23 8.5 8.72 2.71 0.06
Comparable Companies Analysis
17
Recent Stock Performance
18
EPM Comparables Analysis Cont.
Mean Median Weight Mean MedianP/E 3.39$ 1.88$ 15% 0.51$ 0.28$ Forward P/E 6.78$ 5.26$ 15% 1.02$ 0.79$ EV/Revenue 7.10$ 6.16$ 15% 1.06$ 0.92$ EV/EBITA 4.58$ 3.01$ 15% 0.69$ 0.45$ P/B 7.48$ 4.66$ 15% 1.12$ 0.70$ MC/Proved reserves 26.45$ 27.02$ 25% 6.61$ 6.76$
11.01$ 9.90$
Implied Price 10.46$
Implied Price Weighted Price
19
EPM Valuation/Recommendation
WeightDCF 7.30$ 40%Comps 10.46$ 60%Price 9.19$
Implied Price
Recommendation: Watch List