Why I Would — And I Wouldn’t — Invest In Afren Plc Right Now

There is good news and bad news on Afren plc (LON:AFR), argues this Fool.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Where’s the good news within Afren (LSE: AFR)’s story? Well, I don’t think that its shares necessarily offer incredibly poor value for money right now, based on certain assumptions, although some short-term losses could be on the cards. 

The bad news, however, is that I need more evidence from its management team in order to assess the fair value of its equity — and even at 1.85p a share, its stock is not an obvious buy. 

But such a call does not hinge on its restructuring plan. 

Deal Or No Deal? 

While a debt-for-equity swap remains the most likely scenario — as Afren says, that is “the only opportunity to realise value and participate in the recovery of the group” —  it’s now time to stress test assumptions, projections and other data.

So, this is the starting point: Afren hit a stumbling block in 2014, when it recorded a whopping net loss of $1.6bn, mainly “due to a reduction in revenues given the fall in oil prices, a material impairment charge of $1.1bn in respect of the carrying value of the company’s production and development assets and the impact of the curtailment of future capital expenditure on our exploration“.

The oil producer is looking to exploit its lower cost production capacity in its Nigerian portfolio and it is focused on delivering on this strategy. To achieve that, it has lowered its full 2015 capex to $400m, which is way below average, based on its trailing financials. 

In normal times, hence before 2014, Afren used to generate revenues above $1.5bn, but its top line dropped to below $1bn last year. Using $1bn of sales as a base-case scenario, and assuming that its gross margin (sales minus costs of goods sold) stands at about 30%/35% (which is a conservative estimate), its adjusted operating cash flow, including depreciation and amortisation, should comfortably hover around $500m/$600m.

Assuming no changes in working capital (WC) — a negative impact from WC could be absorbed by net cash proceeds of $148m from its pending restructuring — Afren should be able to get very close to breakeven in the first year of trade post-restructuring, assuming the proposed capital structure.

On a pro-forma (“as if”) basis, this implies manageable net leverage of between 1x and 2x, depending on certain elements including operating costs.

At this point, you might smell the opportunity of becoming part of a success story that could deliver outstanding returns, and you may even be prepared to invest part of your savings in it right now.

Not so fast.

Problems

The problem, it seems, is that Afren has taken its eyes off the ball in recent times and its strategy may deliver incrementally lower returns, even assuming a neutral capital structure that does not impact much its operational performance. 

While in the first quarter of 2015 Afren achieved an average net production of 36,035 bopd, which is above the guidance range of 23,000-32,000 bopd for 2015, the company “delivered revenue of $130m and operating cash flows before movements in working capital of $59m, down from $269 million and $169m respectively in Q1 2014“. On an annualised basis, these figures imply lowly revenues of $520m (down from about $900m in 2014) and operating cash flow of $236m. 

That doesn’t look good, and although 2015 numbers may greatly differ from these suggested annualised figures, first-quarter results certainly send a warning to exiting and new investors. 

The fall in revenues in the first quarter “was due to lower realised oil prices and production liftings from Ebok utilised to settle a net profit interest (NPI) liability which is part of the agreement“. And here’s the problem: the terms of the restructuring are stringent, and unless Afren can keep up with the good job that — barring 2014 — it did on the operations side in the past, in my opinion it will unlikely become an attractive investment for a very long time…

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Young female business analyst looking at a graph chart while working from home
Investing Articles

Is Avon Protection the best stock to buy in the FTSE All-Share index right now?

Here’s a stock I’m holding for recovery and growth from the FTSE All-Share index. Can it be crowned as the…

Read more »

Investing Articles

Down 8.5% this month, is the Aviva share price too attractive to ignore?

It’s time to look into Aviva and the insurance sector while the share price is pulling back from year-to-date highs.

Read more »

Investing Articles

Here’s where I see Vodafone’s share price ending 2024

Valued at just twice its earnings, is the Vodafone share price a bargain or value trap? Our writer explores where…

Read more »

Businesswoman analyses profitability of working company with digital virtual screen
Investing Articles

The Darktrace share price jumped 20% today. Here’s why!

After the Darktrace share price leapt by a fifth in early trading, our writer explains why -- and what it…

Read more »

Dividend Shares

850 shares in this dividend giant could make me £1.1k in passive income

Jon Smith flags up one dividend stock for passive income that has outperformed its sector over the course of the…

Read more »

Investing Articles

Unilever shares are flying! Time to buy at a 21% ‘discount’?

Unilever shares have been racing higher this week after a one-two punch of news from the company. Here’s whether I…

Read more »

artificial intelligence investing algorithms
Market Movers

The Microsoft share price surges after results. Is this the best AI stock to buy?

Jon Smith flags up the jump in the Microsoft share price after the latest results showed strong demand for AI…

Read more »

Google office headquarters
Investing Articles

A dividend announcement sends the Alphabet share price soaring. Here’s what investors need to know

As the Alphabet share price surges on the announcement of a dividend, Stephen Wright outlines what investors should really be…

Read more »