The Bull Case for Vaalco Energy and Its African Assets

EGY

Vaalco Energy (NYSE:EGY) is small cap, Houston, Texas-based producer of oil and gas. Its original focus was offshore in the African country of Gabon, but a few years ago it diversified through a beneficial merger that expanded its global footprint. The company delivered a strong Q-4, 2023 earnings report that included news of its further diversification and entry into Côte d'Ivoire. The stock rallied to nearly $8.00 per share following the release of that report. A mixed report for Q-2 that year took the wind out of the company's sails, and thus began the long slide to the current $3.33 level.

Now the Q-3 report is out, and there could be some reason for optimism for a rebound in the company’s shares, despite a miss on EPS and revenue. At a glance, the company trades at low multiples and is currently well below its 200 Day SMA of $3.90 per share. This bodes well for finding a favorable recommendation on EGY.

In this article, we will dig into the particulars on EGY and come up with an investment recommendation for the stock. First we will take a quick look at the macro picture for oil.

The crude oil macro

The oversupply narrative is dominating trading in upstream equities. Crude oil has fallen about 30% thus far this year and may not have yet tested a bottom. Compounding current sluggishness is the war premium that had added back ~$10.00 to the price has leaked away as two of the three international hotbeds of belligerence-Israel/Gaza, and Ukraine/Russia, have shown signs of slowing to a simmer recently, a step down from outright hostilities.

Peace, while a noble objective, is not good for business in oil and gas, as fears of a supply interruption keep traders long futures contracts in times of belligerence. When things calm down, the contracts are dumped on the market and must find a home, at a price. One spot worth keeping an eye on is Venezuela, as the U.S. turns the screws on the Maduro regime. A war in our hemisphere, so near the booming Guyanese ExxonMobil (NYSE:XOM) Stabroeck project, could have profound consequences.

Geopolitical volatility makes it important to pick your entry points carefully when investing in upstream oil and gas companies. There is good news on the horizon for those who take the plunge, however. Fortunately, demand remains strong and has decades to run if the new forecast from the International Energy Agency (IEA) is any guide. Fears of stranded barrels being written off on oil companies' balance sheets are less prevalent than a few years ago.

The thesis for Vaalco

Vaalco has been growing production since its merger with TransGlobe in 2022. This transformed the company from sole reliance on its Gabonese assets to a diversified player with a number of levers to pull globally.

A move last year into Côte d'Ivoire was viewed favorably, and EGY just farmed into another offshore block in that country. In the short run, the company's focus has been on ramping up production in its Egyptian concession and Gabon. Results have been uneven with production progress and efficiency increases in Egypt, offset by a production turnaround and an FPSO refurbishment, combined with rig-related drilling delays in Gabon. This has pushed expected production from a new drilling campaign to the right, adversely impacting the stock.

As the slide below notes, the shutdown and the near completion of the FPSO refurbishment, and then next the arrival of, Borr Drilling's Norve jack up is underway and should spud the first well sometime this month.

Vaalco trades at a low EV/EBITDA multiple-2.8X, and a low flowing barrel valuation- $19K per barrel. Analysts here and on Wall Street rank the company as a strong buy. Price targets are $10.00 per share, but EPS estimates point to small losses over the next couple of quarters, which could delay any rally in the stock.

The company has a quarter of its Q-4 production hedged at $ 60 and plans to increase this to about half. In 2026, EGY plans to hedge about 40% of its daily output.

The company is returning capital to shareholders through a 6.5% dividend yield. The company has a small amount of LT debt and has been implementing a capital reduction and cost-cutting program that should improve cash flow and production.

Catalysts for EGY

An explorer's job is to find oil and gas. Full stop. Operating oil and gas assets is also enhanced by the adjacency of other assets. Sometimes this is called critical mass. It enables cost optimization through several avenues. Gaining operatorship over a block where seismic has already been shot for $3 million seems like a reasonably derisked proposition to me. Someone thought Block CI-705 offshore, Côte d'Ivoire, was prospective enough to shoot seismic, which isn't cheap, so it could be like the last person to pull the handle on a slot machine. Or it could lead to nothing. That's exploration. Dry holes are instructive as well. TotalEnergies, (NYSE: TTE) drilled a test in 2021, and DH'd it. Why did they drill it?

Why does anyone think this area might be prospective? Well, if you go back 400 million years and put the puzzle pieces together to form Gondwana, you find the area now known as Côte d'Ivoire fits nicely adjacent to the areas known as Guyana and Suriname. That should cement it in your head as to what the Geo-types have in the back of their minds at EGY. This sort of thinking about the Atlantic Margin has led to the well-publicized discoveries in Guyana, Suriname, and Namibia.

Snapshot of Atlantic basin (Google Maps)

This is all down the road a piece, even in the success case. In the near term, we have the upcoming drilling campaigns in Gabon, Egypt, and the Baobab field in Côte d'Ivoire -EGY's legacy position from the TransGlobe merger.

No catalyst discussion would be complete without at least a mention of EGY's 60% interest in Block P, offshore Equatorial Guinea. As of this date, a Plan of Development has been approved, and a Joint Operating Agreement is in place. Although Venus (Not to be confused with Total's Venus discovery offshore Namibia) As the slide below discusses, there is future prospectivity in this block. And the two producers and one injector needed to bring on Venus could be done in 2026.

Canada is taking a backseat after several successes in the company's Cardium and Mannville plays in Alberta, with no further drilling planned until 2026. The slide below shows the 2.50-mile horizontal section performing nearly as well as the 3.0-mile type curve.

Q-3, 2025 for EGY

Most notably, the company hit the upper range of most production estimates, but cash flow suffered due to softness in Brent prices. Guidance for the full year expects 5% uplift YoY. Capex was reduced due to the issues with Gabon to optimize cash flow for the quarter. Even so, the company had to call upon its revolver for current expenses. Otherwise, the company has no debt.

Company filings

Risks to the thesis for EGY

Even great deals can get cheaper. Picking an entry point can be frustrating as fundamentals continue to weaken. That's the era we are in right now. As I laid out in the Macro, there are many moving pieces driving oil prices, and most of them are not supportive. No matter how good the price of EGY stock looks relative to the recent past, it can always get cheaper when the market turns against upstream investors.

Your takeaway

EGY’s report reads pretty well. And EGY management is due some deference for their experience in West African operations, going back decades. Their balance sheet management also speaks well for the company. Borrowing money to support operations when interruptions in other projects present cash flow hiccups is no big deal. The company retains ample liquidity, assuming refurbishment with the FPSO goes according to plan.

In my view, Vaalco's strong balance sheet, prospects for improving cash flow in the next year, and low multiples, put a buy target squarely on the company at its current level. The company is currently trading in a range well below its 50 and 200 day SMAs, which is probably more induced by the depressed pricing of Brent than anything else.

I am giving EGY a Strong for investors with a high risk profile, seeking capital growth and competitive shareholder returns.

By David Messler for Oilprice.com

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