Sterling say cash flow will increase by 400% in 2006

Mid December......


Sterling Energy
Target : 28p

Results announced : Sterling Energy has reported results for the
six months 30 September. Revenue and PBT of £24.471m and
£7.227m were significant year on year increases on the £6.735m
and £2.786m reported respectively for the same period last
year. The company highlighted its “sizeable and increasing
unrestricted cash balance, strong cash flow despite the
Chinguetti issues, a growing exploration portfolio with a
significant exploration programme in the coming year”.

Chinguetti update: The key feature of the results announcement
was its update on its operations at the Chinguetti oil field
offshore Mauritania. At the end of August Sterling’s partner at
Chinguetti, Hardman Resources, stated that the wells of the
original development plan are only likely to recover c.50% of the
original proven and probable reserves estimate of 123m barrels.
However in today’s statement Sterling stated that operational
uncertainties have forced them to reduce their estimates by 43%
to 80m barrels. This comment is encouraging as it signals some
optimism over Hardman’s ‘worst-case scenario’.

Oil reserves : Following yesterday’s results we have some slight
adjustments to our valuations. Assuming a worst case scenario
where only 60m barrels are recovered at Chinguetti and oil at
$50/bbl, reduces the value of Sterling’s 8% holding and royalty
interest to c.£65m (4.5p per share). We value the company’s
separate 5.28% Tiof royalty on 60m barrels at £16m (1p per
share), as its Tevet royalty at c.£5.5m (0.5p per share).

Gas reserves : The value of Sterling’s Banda gas royalty in
Mauritania remains at £42m (3p per share). The value of its
proven and probable gas reserves in the Gulf of Mexico stands at
£90m (6.5p per share), with its 3P Gulf of Mexico gas reserves
risked at 50%, at £37m (2.5p per share).

Liquid assets : When Sterling’s liquid assets such as its Forum
Energy 14.7% shareholding worth £3m, and its net cash balance
of £45m are also taken into account, further NAV per share of
3.5p is revealed, generating a worst case NAV per share of
21.5p. We have conservatively valued Sterling’s entire additional
exploration licences at Madagascar, Gabon, Guinea, Bissau and
Cameroon at £60m (6.5p per share).

Attractive upside : This gives us a worst case 12 month price
target of 28p, based on a conservative valuation of the
company’s net asset value per share. BUY