From hold to outperform..

With a price target of $80. What’s going on?

• Pavel replaced Wayne at RJ and they worked together for years, so it’s probably a good idea to keep track of Pavel’s calls.
• He is satisfied that there won’t be further new projects to delay of the FID’s of the present projects with Mitsui, EWC, Flex/Samsung
• Not mentioned, but Shell going ahead with a (bigger) FLNG has given this new approach further credence.
• Not mentioned either, but the gas market is tightening (see earlier BBC article posted here)
• For IOC is in talks to achieve two preliminary (HoA) off-take deals, testifying to the improving conditions on the LNG markets
• Let’s not forget that RJ uses P1 figures to arrive at NAV ($110). P1 figures (6.47Tcf and 105.3mmbbls) are a lot smaller then the P2 figures (8.59Tcf and 128.9mmbbls)

The RJ report:

InterOil Corp. – Outperform 2 – Target price = $80.00;

InterOil Corp. IOC:NYSE – Upgrade from Market Perform 3 to Outperform 2. Target Price goes from NM to $80.00.

Upgrading IOC to MO2 at 54% of NAV, Despite Back-End-Loaded Catalysts

Recommendation: On April 12, we downgraded InterOil from Outperform to Market Perform, noting that the pushout of the final investment decision (FID) until late 2011 diminished near-term catalysts and frustrated many investors. With the shares now trading at just over half of NAV, we believe that they have been marked down to a level that again presents a worthwhile entry point, and therefore, we are upgrading them to Outperform. With speculative stocks like IOC, one needs to be opportunistic, and we are also heartened by what has finally become an unambiguous message from management: no new project deals until FID is already in place. As a tactical matter, we think the stock will directionally trade up toward FID. As always, we are balancing (1) InterOil’s long-term cash generation potential and upcoming newsflow with (2) operational, cost, and timing risks as the upstream assets, condensate plant, and LNG plants are developed over the next three-plus years.

* Reviewing the roadmap to cash flow. Since the original Elk/Antelope discovery in 2006, InterOil has been proceeding along two parallel tracks: (1) a drilling program aimed at assessing the extent of the resource and (2) a monetization program aimed at creating an export outlet for the stranded gas and condensate. For now, drilling is on hiatus, and in any case, the market has long been focused on monetization. InterOil has brought in three partners: Mitsui for condensate stripping and Energy World and FLEX for LNG. The decision to align the three components of the resource development has the benefit of reducing capital costs but also means that FID must occur simultaneously for everything. Thus, FID for the Mitsui/Energy World/FLEX projects was pushed back last month for the second time, from June 30 to year-end. We believe this deadline will be met. All three components are expected to have a 30-month construction timeline, which equates to first production in mid-2014. Of course, we have underscored many times that large-scale energy projects, including LNG plants, typically come in over budget and behind schedule.

* What will happen prior to FID? The short answer is, probably not much, but with InterOil, we have learned to never say never. Once the next well spuds (a 4Q event), exploration surprises (positive or negative) are always a possibility. Also, it’s possible that InterOil will soon sign LNG offtake agreements, ideally with a resource monetization component – the long-awaited selldown. We think this will most likely be finalized post-FID, though a preliminary “heads of agreement” – still a tangible catalyst – is realistic beforehand.

Valuation: IOC is currently trading at 54% of our “de facto” proved NAV estimate of ~$110 per share. While recognizing that valuation is not very meaningful until FID and/or a resource selldown, the 54% figure can be loosely compared to medians of 148% (large-cap) and 139% (small/mid-cap) for traditional, production-stage E&P companies. Our $80.00 target price is based on a ~25% discount to NAV, which comprises a sum of the parts valuation of each of the business segments, as detailed on the following page.