Offshore Megaproject Risks And Weak Power Pricing Will Pressure Future Earnings

Catalysts

About Galp Energia SGPS

Galp Energia SGPS is an integrated energy company with upstream, refining, midstream, commercial, and renewables activities.

What are the underlying business or industry changes driving this perspective?

• The focus on large offshore oil projects such as Bacalhau and Mopane concentrates future growth on capital intensive assets. These assets may face higher regulatory, cost, and execution risks, which could pressure future earnings if ramp up or partnership plans slip versus expectations.
• The reliance on upstream oil production levels near the upper end of current guidance and a dividend breakeven tied to an oil price level creates exposure to weaker commodity pricing or operational disruptions. This exposure could weigh on revenue and free cash flow if volumes or prices soften.
• The current supportive refining margin environment and robust system availability may not persist. The ongoing large turnaround with over 5,000 workers on site raises operational and safety complexity that could reduce utilization and narrow refining margins, impacting EBITDA from this segment.
• The expansion of LNG sourcing from the U.S. and trading heavy midstream activity brings counterparty, contract, and volume risks. Any adverse changes in flow patterns or spreads could reduce trading contributions, which would put pressure on group EBITDA stability.
• The build out of low carbon projects, including electrolyzers, solar generation, ancillary services, and storage, is occurring alongside a low pricing environment for power. If returns on these investments remain modest, the higher CapEx could dilute net margins and delay meaningful earnings contributions from renewables.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on Galp Energia SGPS compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Galp Energia SGPS's revenue will decrease by 7.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 3.3% today to 6.1% in 3 years time.
• The bearish analysts expect earnings to reach €943.3 million (and earnings per share of €1.42) by about July 2029, up from €647.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as €1.3 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 17.1x on those 2029 earnings, down from 24.4x today. This future PE is lower than the current PE for the GB Oil and Gas industry at 24.4x.
• The bearish analysts expect the number of shares outstanding to decline by 0.84% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.17%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Upstream production stood at 115,000 barrels per day with high fleet availability and limited unplanned events below historical trends. If this level of operational reliability is sustained, it could support upstream revenue and EBITDA more than a bearish view assumes, and in turn support earnings.
• Group EBITDA of €911 million in the quarter and free cash flow of €548 million, combined with net debt to EBITDA of 0.4x and net debt of €1.2b, point to a balance sheet that may absorb periods of weaker commodity prices better than expected. This could limit downside pressure on net margins and earnings.
• First oil from the Bacalhau FPSO, described as one of the largest and most efficient production units in operation, and the progression of value accretive partnership discussions for the Mopane asset in Namibia, may set up future production and cash flow contributions that support long term revenue and earnings.
• The build out of low carbon projects, including the first electrolyzer module and efforts to optimize revenue from solar generation through ancillary services and storage, could gradually diversify cash flows away from pure oil price exposure and help support long term EBITDA and net margins.
• The commercial segment posted EBITDA of €119 million, up 28% year on year with help from an improved business environment in Spain and operational enhancements. If these improvements persist, the commercial and midstream segments, including LNG sourcing from the U.S., could provide more stable earnings and cash generation than a bearish case implies.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Galp Energia SGPS is €18.4, which represents up to two standard deviations below the consensus price target of €21.98. This valuation is based on what can be assumed as the expectations of Galp Energia SGPS's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of €26.0, and the most bearish reporting a price target of just €18.4.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be €15.6 billion, earnings will come to €943.3 million, and it would be trading on a PE ratio of 17.1x, assuming you use a discount rate of 7.2%.
• Given the current share price of €20.96, the analyst price target of €18.4 is 13.9% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.