NEP 2010 Earnings Projection


Even though we haven't finished 2009, China NorthEast Petroleum (NEP) has given us a solid, yet conservative guidance for Q4, so I am looking forward to 2010 with my projections in this post. I've come up with four scenarios to present, based on what oil prices might do next year. My nature is to be conservative when I create forward looking projections, so just know that when looking at the numbers.

In order to make the projections I've split NEP into their two operating segments, Drilling and Oil Production. We don't have much more information on the Drilling segment then what I presented in my last post on NEP, so I will be basing my estimates mainly on info from the press releases and the 10-Q.
As for the Oil Production numbers, I have been keeping a detailed spreadsheet of NEP's past financial results, as well as projections based on those past results, for two years now. At this point I feel that I have a very good handle on what levels of expenses to expect based on oil production and oil price levels. In my projections I won't be showing all the details, just the projections for producing wells, average oil price, revenues, and net income. But know that these numbers come from my more detailed spreadsheet.

Lets quickly look at the major factors to consider when projecting revenues and expenses. This only applies to the oil production as for Tianchiang I've simply assumed they will drill 220 wells, receive about $185k per well, and have a 30% profit margin.

Obviously the main consideration is the average oil price. My brother (see his last post here) and I believe that the US Dollar will strengthen in the coming months, and I also expect the US to relapse into a 2nd recession next year, so I'm not one of those people expecting oil over $100 again next year. The other factor is the level of production. I've assumed increasing production as the year progresses based on NEP's stated plan to add another 60-70 wells.

Cost of Sales:
Production Costs: NEP incurs about $5/barrel
Depreciation: This numbers ran between $9.50 and $10 per barrel in 2009.
Government Oil Surcharge: China charges a tax on on oil revenues when oil is higher then $40/barrel. This tax starts at 20% and increases to 40% on the price over $60. See NEP's explanation on page 29 of their 10-Q
General and Admin:
NEP has low G&A costs. Typically they have about $1mil in general operating costs, and then another $750-1000k interest and amortization expenses on the loan they received in 2008.
NEP's tax rate this year has been about 32%.

Now that we've gone over my assumptions, here are the four scenarios:

1. Oil stays in a tight band all year between $60-70, averaging $65 each quarter (extremely unlikely but a nice base scenario). In this case NEP would have about $1.21 EPS in 2010.

2. Oil moves down in the first half of the year and then back up, but finishes next year lower then it is today. This is my favorite conservative projection. In this case NEP would have about $1.07 EPS in 2010.

3. The world enters another serious recession and deflation hits. Oil drops from current levels to about $35/barrel in the 2nd half of the year. I really doubt this would happen, but wanted to put it in to show that NEP will still earn about $.60 EPS even in this "shit hits the fan" scenario.

4. Continued inflationary pressures and a greater concern by the market that peak oil has arrived pushes prices up throughout the year to end 2010 at about $100/barrel. This would be ideal for us and NEP would have about $1.45 EPS in 2010 if this happened.

2010 NEP price expectations

Having been invested in this great company for two years now, I have come to realize that the stock will never move like you would expect it to. Still, 2010 seems primed to become the company's best year yet, and thus I do expect the stock to have a nice run-up in the next 12 months. Assuming that NEPs meets their projections of $.80/share in 2009, today we have a stock with a TTM PE of 6.5 ($5.20/$.80), that will likely earn between $1.05 and $1.10 next year even if oil drops 15% from today's prices, and will earn $.60 even if oil tanks back down to early 2009 levels.
I find it hard to believe that we will still sport a PE under 10 in a year (although its not impossible), so I think that we should see this stock hit $10 by next fall. that's a 100% gain from today's levels. If more institutions find the stock and it gets on a roll, it would not be out of the question to see a PE of 15-20 on it, which would move the stock to $15-20. This is what all of us owners are dreaming about, but I'm certainly not expecting this yet.
Of course, caution is also warranted because if oil prices move down to the $35-40 range again, I'm sure we could see this move under $3.50 again, and possibly down to $2.50. Just know that at that level you'll be picking shares up for 4x their worst earnings potential.

The bottom line is that this a very well managed company that isn't taking crazy risks in order to increase their stock price. Management is clearly thinking long term and I believe that that in 10-15 years any stockholders that have held the stock the entire time will be very happy, but I will go more into that in my next post.

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