Karoon Energy (ASX:KAR) - Buy Baby Buy 🚀

Overview

Our analysis indicates that Karoon Energy (ASX: KAR) is generating exceptionally strong free cash flow (FCF), with an FCF margin of ~45%—well above industry averages.

Supported by a $65 per BOE base case, stable production growth (+3.8% annually), and a well-structured CAPEX program ($120M p.a.), Karoon is positioned to generate ~$293M USD in annual free cash flow.

The market might be discounting execution risks, but Karoon’s high-margin, low-debt structure, and buyback program provide a strong fundamental case for a re-rating. Applying a DCF-based valuation and peer benchmarking, the fair value per share comfortably supports a price north of $4.50, with further upside if oil prices remain elevated or production efficiency improves.

The disconnect between Karoon’s strong fundamentals and its current trading price presents a tremendous investment opportunity.

Enjoy. 🚀

1. Underlying Assumptions & Methodology

The foundation of this valuation analysis is based on the following, with particular emphasis on free cash flow, rather than net earnings:

• Forward Oil Price Projections: Established via a Monte Carlo simulation, incorporating geopolitical supply risks, OPEC+ output strategies, and long-term energy transition factors. The base case assumes an average price of $65 per BOE over 10 years.
• Production Stability Forecast: Using historical decline rates, company guidance, and the mitigating impact of the Who Dat well, a 3.8% annual production growth rate was derived.
• Discounted Cash Flow (DCF) Assumptions:
  • Discount Rate (WACC): 10%
  • Terminal Growth Rate: 5%
  • Projection Period: 10 years
• Financial Assumptions:
  • COGS per BOE: $20.00 (based on latest financial reports)
  • Gross Margin: 69.2%
  • CAPEX: $120M USD annually
  • Interest Expense: $36.75M USD annually
  • Operating Cash Flow: $449.8M USD annually
  • Free Cash Flow (FCF): $293.05M USD annually, ~45% of revenue

Why is the FCF rate High?

1. Strong Operating Margins – With a 69.2% gross margin, Karoon has relatively low costs per barrel compared to its realised sale price.
2. Efficient CAPEX Allocation – adopted a conservative peanut butter spread of $120M per year, adjusting for historical developmental CAPEX items attributable to large one off projects, as Karoon evolves from explorer to producer.
3. Low Leverage Impact – Interest expense is only ~$36.75M per year, meaning debt servicing is not consuming significant cash flow.
4. High Cash Conversion – A large portion of earnings converts directly to free cash flow, reflecting strong operational efficiency. Which underpins our valuation, rather than using net earnings.

Industry Comparison - how's KAR FCF compare?

• Major Integrated Oil Companies (e.g., ExxonMobil, Shell) → Typically 20-30% FCF margin
• Mid-Cap Independent Producers → Often 15-25% FCF margin
• High-Cost Producers (e.g., Offshore or Heavy Oil Projects) → Can be below 10%

2. Fair Value Analysis – Production & Price Sensitivity

The heatmap visualisation illustrates the relationship between Karoon Energy’s fair value per share, oil price fluctuations, and production variance.

Key takeaways:

• At $65 per BOE and 10M BOE annual production, fair value is significantly above current market pricing.
• If oil prices drop to $50 per BOE, the valuation weakens, but Karoon remains profitable due to it's low production cost advantage.
• Upside scenarios ($75-$85 per BOE) significantly enhance fair value.
• Who Dat’s contribution enhances production stability, reducing downside risk.

3. Why the Market Price Might Not Reflect Fair Value

Despite strong underlying fundamentals, Karoon Energy’s share price may not be trading at fair value due to:

1. Market Scepticism on Future Free Cash Flow – Investors may discount Karoon’s ability to sustain long-term FCF growth, despite positive operational developments.
2. Risk Perception & Discount Rate Sensitivity – The market could be pricing in a higher discount rate (~12-15%) due to perceived execution risks.
3. Lack of Institutional Coverage – As a mid-cap oil producer, Karoon may have limited large-fund participation, which suppresses valuation multiples.
4. Sentiment Toward Energy Transition – Some investors may be underweighting oil & gas stocks due to long-term energy transition concerns.

While these factors may suppress share price in the short term, the fundamental value proposition remains strong.

4. The Share Buyback Program – Positive Impact on Share Price

Karoon’s announced share buyback program is a major positive catalyst, as it:

✅ Reduces outstanding shares, thereby increasing per-share earnings and free cash flow.

✅ Signals confidence from management that the company is undervalued.

✅ Creates direct buying pressure, likely pushing share price higher in the near term.

Assuming continued execution of the buyback program, per-share fair value could increase by 5-10% over the next 18 months.

5. Conclusion & Investment Implications

📌 Karoon Energy appears undervalued relative to its fundamental free cash flow generation potential.

📌 The market may be over-discounting risks while under-pricing positive operational catalysts.

📌 The Who Dat well stabilizes production forecasts, providing a downside buffer.

📌 Recent share buybacks further enhance valuation upside.

🔎 Final Thought: If Karoon successfully executes its operational strategy and buyback program, fair value estimates suggest significant upside potential from current trading levels.

Ends.

Disclaimer:

This narrative is for informational purposes only and does not constitute investment advice. Investors should perform their own research, assess their risk tolerance, and consult with financial professionals before making any investment decisions. All projections and financial scenarios are based on current information and are subject to change. Investing in any company can involve significant risks, including potential loss of capital. Do your own research.