RBC's Sydney-based Ben Wilson said AWE's recently rejected 80c/share takeover bid from US-based Lone Star Fund reinforced his own firm's view of the oiler's growth pipeline.
This growth should see AWE become free cash flow positive by 2017-18 and sustain a net cash position from 2018-19 based on current producing projects plus an initial 30 terajoules/day from a scaled-up Waitsia development, increasing gas production from the mid-life extension of the BassGas project, plus the removal of the capital commitments from its divested assets.
Given RBC's unrisked valuation on AWE of $1.80/share and its view of recovering commodity prices over the medium term, the Canadian bank sees value in the stock even at current levels and even sees the potential for an improved bid, despite many analysts believing Lone Star's involvement is dead in the water.
While the Lone Star bid was clearly a case of taking advantage of a distressed share price, Wilson said private equity was attracted by the large reserve and contingent resource base, particularly in the Perth Basin, located in a first-world economy close to key markets.
Suffering
AWE has, however, suffered worse than its peers under low oil prices, with its share price performing particularly poorly relative to its mid-cap and junior exploration and production peers since the start of last year.
Its underperformance is even more pronounced when considering the Lone Star bid fuelled a 25% rally over two trading days over the past week.
RBC puts AWE's underperformance down partly to a strong period of relative outperformance compared to its peers over much of 2014 as its Eagle Ford Shale asset grew in scale.
AWE was one of the last Australian midcap energy plays to suffer material share price falls post the November 2014 OPEC meeting that triggered the major oil price plummet.
AWE previously rejected an all-scrip bid from ASX-listed Senex Energy in December 2013, which implied an AWE share price of 144cps in an oil price environment roughly 80% higher in Aussie dollar terms than now.
While RBC's investment thesis on AWE is not premised on the prospect of Lone Star returning with a higher bid, the Canadian bank does believe that corporate interest reinforces its positive view of the junior's strong organic growth opportunity set.
AWE recently sold its US Sugarloaf shale asset for $A230 million post-tax, and with the pending sales of the Cliff Head offshore oil field in Western Australia and Lengo gas development in Indonesia, AWE's portfolio now mainly offers exposure to east and west coast Australian domestic gas prices - a key ingredient to the story.
AWE also has oil exposure via the pre-development 100 million barrels-plus Ande Ande Lumut oil field offshore Indonesia and the mature Tui Area oil field in New Zealand.
Thus while its portfolio size has been reduced in terms of number of assets, it maintains considerable material resource upside potential through the Perth Basin onshore tight gas assets, BassGas' potential expansion with Trefoil and AAL.
The divestment of the Sugarloaf has eliminated any debt that company had, leaving it well positioned to execute its forward growth strategy which has lured RBC.
East coast moves
On the east coast, Wilson believes that the redirection of Surat and Cooper Basin gas formerly used by the southern states to the three Gladstone LNG export terminals and declining Otway Basin and Bass Basin production points to further tightening of the Victorian gas market.
"Channel checks suggest deals are being done on an oil linked or CPI-linked basis at prices nearing $A7/GJ," Wilson said.
"West Coast spot pricing remains depressed at $3-4/GJ due to a combination of oversupply and weaker resource sector demand.
"We believe the prospects for a recovery in WA gas prices is contingent on much of the North West Shelf domestic gas production being redirected to LNG exports"
While this is RBC's base case, Wilson warned there was still considerable uncertainty associated with this outcome, which is reflected in the relatively low risk weighting on his valuation of AWE's Perth Basin assets.
"The size and pace of the development of AWE's Perth Basin tight gas discoveries will likely be determined largely by price recovery and customer appetite," he said.
Forecast folly
However, Wilson also warned that "an investment thesis that is largely premised on sharply escalating [as in the east coast] and sharply recovering [west coast] domestic gas process is by no means a sure thing".
Both markets are subject to supply and demand dynamics that are difficult to pin down.
On the east coast, AWE has gas coming off long-term contract from both Casino and BassGas over 2018-19, and RBC believes a recontracted gas price of above $7/GJ is feasible.
