New Zealand Oil & Gas shares are overvalued, says Morningstar, which believes a fair value would be 60 cents a share.
The shares, which opened yesterday at 79.5c, "are too risky for most investors", the investment research firm says in a report.
But, for those looking for small-company oil and gas exposure, the NZOG did have some "attractive attributes", including a potential "valuation upside" from exploration, Morningstar said.
But if it did not find more oil and gas, sales and earnings would gradually decline.
NZOG had a relatively large cash balance of $135 million at the end of June, which underpinned Morningstar's equity valuation of $250m. The cash balance helped smooth ups and downs in earnings and lumpy exploration costs.
The mix of cash-generating assets with highly uncertain exploration activities was good - but that could not completely counter operating in a sector with highly uncertain outcomes.
The lack of debt was appropriate given uncertainty about earnings and exploration. "This business requires a significant amount of capital and success is not guaranteed," Morningstar said.
NZOG has a 27.5 per cent stake in the Tui oilfield and a 15 per cent stake in the Kupe gasfield.
"Long-term viability is increasingly dependent on exploration success from the portfolio of assets in New Zealand, Tunisia and Indonesia, which is speculative," Morningstar said.
Exposure to oil prices and exploration uncertainty made the shares suitable "only for high-risk-tolerant investors". Morningstar said it would cease coverage of NZOG at the end of September.
Tui and Kupe would continue to generate cashflow, but would naturally deplete with time. That meant NZOG would become increasingly reliant on exploration success, leading to it being a higher investment risk.
The Pateke prospect, an extension of the existing Pateke reservoir at Tui, was drilled earlier this year and would extend the reserve life of Tui.
But the Oi-1 and Oi-2 wells failed - a reminder of how uncertain oil and gas exploration could be. One of the partners in the Tui field last week revealed a cost blowout in drilling wells at Pateke and Oi recently, with total costs of about $190m for all the partners.
NZOG also recently reported that it was dropping out of its exploration in Tunisia.
Meanwhile, NZOG's speculative Kaheru prospect, off the New Zealand coast, was expected to be drilled in the first half of 2015.
The onshore Kisaran project in Indonesia was drilled last year and evaluated for its commercial potential.
Morningstar's financial model assumed an oil price of US$100 a barrel and an NZ-US exchange rate of US80c, but excluded potential exploration success.
NZOG was expected to make a NZ$17m profit in the 2014 June year.
It should be able to internally fund its exploration programme and maintain its dividend for the next few years, the report said.
- Fairfax Media