This has been Repsol's (OTC:REPYY) annus horribilis, as the Argentine government's decision to steal YPF (or "nationalize"/"expropriate", if you prefer) walloped the stock and forced Repsol's management to re-evaluate the company's core operating priorities and capital structure. While I would never suggest that losing a business as large as YPF is a long-term positive for the company, this restructuring was arguably overdue and Repsol has a lot of appealing production/reserve growth potential.
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What's Done Is Done
I won't dwell too much on the Argentine government's decision earlier this year to steal YPF from Repsol. Frankly, the reasons, rationalizations and logic to the move don't matter - the Argentine government did what it did, and Repsol has no choice but to move on.
Losing YPF cost Repsol somewhere between one-quarter and one-third of its net asset value NAV (by my calculations), as well as roughly half of its reported reserves (and incrementally more of its production). While Repsol may someday get compensation for this, the odds of the company being "made whole" again seem slim, and I don't think investors help themselves by putting much hope in future compensation from Argentina.
Slimming And Restructuring
In an effort to improve the company's post-YPF capital structure, management has gotten busy re-thinking Repsol's core operations. A Chilean liquefied petroleum gas (LPG) business was sold for over $500 million, and the company is actively looking to sell its liquefied natural gas (LNG) business. Given that this business is largely focused on marketing and trading, it's not really core it should shave billions off of the company's debt load.
Will the company do more? I have to admit that I wouldn't mind seeing Repsol spin off its downstream operations. Absent that sort of dramatic move, I could also see Repsol selling some partial interests in certain upstream projects if they really need to raise additional capital without serious dilution.
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Attractive Upstream Growth Potential ... but with Some Risks
Repsol probably doesn't get quite the credit it should for a pretty aggressive and successful record of exploration in South America and Africa. With that success, Repsol could be in place to grow production at a rate in the high single digits over the next five or six years - a rate that other majors such as Exxon Mobil (NYSE:XOM), BP (NYSE:BP) and Chevron (NYSE:CVX) will find challenging to match.
The company has been quite successful in Trinidad & Tobago, and discoveries in Peru, Bolivia and Venezuela should all help grow production. Even more significant, Repsol is a player in Brazil's large offshore discoveries, and Brazil could become 10% or more of the company's production base within 5 years.
Africa, too, looks to be a significant part of Repsol's future. Not unlike Eni (NYSE:E), Libya is an important operating area for Repsol today and discoveries in Angola and Namibia could make Repsol a player in Africa.
Now for the bad news - not many of the countries I just mentioned are what I would consider to be stable or dependable. I'm not too worried about Brazil (despite how the Brazilian government has treated Petrobras (NYSE:PBR) and Transocean (NYSE:RIG)), nor Trinidad, but it's not hard to imagine how Bolivia, Venezuela, Libya, Angola or even Peru could perhaps someday try to turn the screws on Repsol as Argentina did.
To that end, Venezuela's government has apparently communicated to Repsol that it does not want the company to go to the International Center for Settlement of Investment Disputes (ICSID) for arbitration (Venezuela needs Argentina's support in the area). With over 10% of the company's production coming from Venezuela, that's not a request that Repsol can just ignore.
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The Bottom Line
Repsol's stock has already seen a solid rebound from the worst of the YPF-related selling, but is still well below even recent highs. Although Repsol's upstream operations do carry what I would call above-average risk, that growth potential is still impressive and management seems serious about reorganizing and refocusing operations.
What is Repsol worth? On one hand, I have a hard time making the case that Repsol's shares should get a premium to those of Apache (NYSE:APA) or Chevron, but production growth often represents the primary driver for these stocks. Giving Repsol the same 4.5x multiple to 2013 EBITDA suggests a target of about $20 (close to today's price), while a slight nudge to 5x would push the target closer to $23.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.