Talos Energy: Sunspear Discovery And CO2 Storage Could Push The Price Up

Talos Energy Inc. (NYSE:TALO) may see production increases in 2024 from the Sunspear discovery as well as Venice and Lime Rock. In my view, thanks to the CO2 storage market growing at close to 21% CAGR and TALOS’s storage portfolio, the company may receive significant demand for the stock. There are obvious risks associated with future crude price volatility or lower oil reserves than expected, however, TALO does look very cheap at its current valuation.

Talos Energy

Talos Energy stands out as an independent oil exploration and production company with a technical focus. Consolidated with subsidiaries, it operates in the US and the Mexican Sea, covering Upstream and carbon capture and sequestration development.

The environmental focus of the company is reflected in emissions reduction initiatives along the Gulf Coast. The company integrates decades of offshore technical experience, using geology, geophysics, and engineering to discover new resources and safely optimize production.

The company’s business model focuses on exploration, drilling, and production, with capital expenditures linked to the view of future oil and natural gas prices, subject to external volatility. Marketing covers all production, serving key customers such as Shell (SHEL), Valero Energy (VLO), and Chevron (CVX).

Earnings Release, And Expectations From Other Analysts

With less EPS GAAP than expected and better quarterly revenue growth, Talos Energy received a recent increase in EPS revisions in the last 90 days. With this new information and the stock trading at a multi-year depressed price mark, I believe that having a close look at Talos makes a lot of sense.

It is also quite beneficial that most analysts out there are expecting net sales growth in 2024, net margin increase, and FCF increase in 2024. The most remarkable is the figure expected for the year 2025, which is close to $405 million. With the market capitalization being lower than $2 billion, I believe that the current valuation appears a priori quite limited.

Extensive Expertise In The Acquisition Of Targets And Recognition Of Assets With High-Impact Exploration Could Bring Significant FCF Growth

As highlighted by Talos, the company runs a proven full life cycle investment approach, which I believe could bring significant FCF in the coming years. The strategy includes reprocessing of seismic activity, asset management on acquired infrastructure, and value-focused M&A efforts.

Talos reported 13 acquisitions since inception and the addition of 100 MMBOE of net proved reserves, indicating a lot of expertise in the M&A world. Talos recently noted that divestments by large corporations could be a beneficial driver for future acquisitions. As a result, I believe that we could see new reserves being added in the coming years.

Estimated Production Volumes From Venice And Lime Rock Given For The Years 2025 And 2026 Could Bring Substantial Net Sales Growth

In the last quarterly report, the company noted that Venice and Lime Rock assets could bring NPV-10 close to $250 million, and first oil could be delivered from 2024. Given the expectations noted by management, I believe that we could see an increase in production from 2024.

The Sunspear Discovery Could Bring New Oil Production In 18-24 Months

The new discovery announced by Talos in 2023 is expected to bring first oil in 18-24 months. In my view, further information about the reserves found that may be delivered soon could push the stock price up. Keep in mind that more production will most likely mean more net sales growth and FCF growth.

The Storage Portfolio Of Talos Energy May Bring Net Sales Growth

Safety, sustainability, and corporate responsibility are key principles, highlighting the low environmental footprint and the publication of ESG reports. With the industrial carbon capture growing at close to 21.5%, I believe that the CCS projects presented by Talos could help the company raise funds and accelerate net sales growth. We are talking about close to 1.7 billion tons of gross prospective storage resources, which also brings the potential for new key partnerships. Additionally, if the company receives the two class VI permit applications submitted in 2023, business opportunities could also multiply.

North America led the industrial carbon capture, utilization, and storage market, in terms of value, in 2021 and is projected to register a CAGR of 21.5% between 2023 and 2030. Source: Carbon Capture, Utilization, and Storage Market

Balance Sheet

As of September 30, 2023, Talos Energy reported cash and cash equivalents worth $13 million, accounts receivable from trade of about $181 million, prepaid assets of close to $86 million, and total current assets of about $411 million. I do not like the fact that the current ratio is lower than 1x, however, I believe that given the total amount of reserves and the total amount of debt, liquidity does not seem an issue.

With proven properties of about $7.691 billion and total property and equipment worth $4.007 billion, Talos Energy does look cheap with a total market capitalization of close to $2 billion. The company also reported restricted cash worth $101 million, equity method investments close to $141 million, notes receivable worth $15 million, and total assets of $4.753 billion. With an asset/liability ratio close to 1x-2x, I would say that the balance sheet appears healthy.

In 2023, the total amount of debt increased substantially as did the total amount of reserves. It appears clear that bankers do trust Talos Energy’s appetite for M&A investments and the acquisition of new oil reserves.

The list of liabilities includes accounts payable worth $125 million, with accrued liabilities of about $205 million, accrued royalties close to $54 million, and accrued interest payable of about $30 million. With long-term debt of close to $1.018 billion, Talos also reported asset retirement obligations worth $747 million, operating lease liabilities of $18 million, and total liabilities of about $2.691 billion.

Debt Assessment, Cost Of Capital, And Net Debt

With leverage of close to 1.1x, I do not believe that the risk is that significant. Having said so, the interest rate being paid does not seem small. Talos reported debt including interest of 12% and 11.75%. With these numbers in mind, I believe that a WACC of around 12% and 15% would make sense.

My Cash Flow Expectations Based On Previous Discoveries, My Previous Assumptions, And Recent FCF Numbers

My expectations include a 2029 net income of close to $41 million, with depreciation, depletion, amortization, and accretion expense close to $656 million, amortization of deferred financing costs and original issue discount of close to $37 million, and equity-based compensation expenses of $42 million.

My expectations also include net cash received on settled derivative instruments of about -$753 million, settlement of asset retirement obligations of close to -$148 million, and changes in accounts payable of close to $48 million. Besides, with changes in other current liabilities of $288 million, 2029 CFO could be about $941 million. If we also assume 2029 exploration, development, and other capital expenditures of about -$237 million, 2029 FCF would be $704 million.

For the assessment of future exit multiples, I took a look at the valuation of competitors. The sector median EV/EBITDA stands at close to 5.3x, and the price/cash flow is about 4.5x. Talos Energy appears to trade a bit cheaper than competitors.

In the past, Talos reported EV/FCF between 3x and 9x and cash flow between $240 million and $700 million. Given these figures, I believe that exit multiples close to 3x FCF and 10x FCF would make sense.

With a WACC between 12% and 15% and EV/FCF between 3x and 10x, a share count of 124 million would imply a median fair price between $23 and $33 per share. Note that I also obtained a maximum price of close to $41 per share. Finally, I also obtained a median internal rate of return not far from 10%-18%.

Competitors And Risks

In my opinion, the oil market is very competitive. Talos faces intense competition in exploration, acquisition of reserves, leases, equipment, and personnel. It competes with large integrated companies and independent exploration and production companies, some with significantly greater financial resources. Although these companies can better adapt to changes in the industry, they rely on their high-quality production base, seismic technology expertise, and a balanced mix of deep and shallow water assets in the Gulf of Mexico. Its operational capacity reinforces its solid competitive position in this challenging environment.

Talos Energy’s operations are accounted for using the full cost method, capitalized acquisition, exploration, and development costs. Low crude oil prices or volatility may increase property depreciation risk. In Mexico, unproven properties are not amortized, but disputes and agreements can affect their value.

Inflation in the U.S. has raised operating costs, and the Federal Reserve has raised interest rates to curb inflationary pressure, which could impact the cost of capital and affect financial results. Larger interest expenses could lead to lower net income growth and FCF growth.

I also believe that engineers assessing crude oil reserves could make mistakes. Total proven or unproven reserves could be lower than expected, which may lower the book value per share. Revaluation of reserves may also bring lower production expectations and bring down the stock price.

Conclusion

With the recent Sunspear discovery and oil production expected from Venice and Lime Rock, Talos Energy could see an acceleration of oil production in 2024 and future years. Besides having one of the largest storage portfolios in the country and the CO2 storage market growing at close to 21% CAGR, Talos could receive significant demand for its stock. Despite intense competition, I believe that the company’s technical, operational, and seismic technology expertise, along with a high-quality production base, provides it a strong competitive position. There are risks associated with crude price volatility, lower oil reserves than expected, or inflation, however, I believe that Talos is quite undervalued.