SOCO (LSE: SIA) is troubled and may not be a very different story from Afren (LSE: AFR), the bears argue these days. I think they are completely wrong, yet there are a few reasons why I don’t fancy SOCO and I wouldn’t invest in it even after its recent fall. Its shares are down 40% since last week, when it reported 2014 results.
That said, I certainly prefer SOCO to Ophir Energy (LSE: OPHR), which doesn’t look investable to me.
Soco: No Bailout From Suitors
SOCO, a £500m oil and gas explorer, has been on my radar for about a decade. Its stock now changes hands at 155p, but had been trading between 300p and 400p for a long time as investors expected a blown-out offer to emerge at some point — well, they’ll have to wait a bit longer.
In a big marketing push, its board members have repeatedly stressed the incredible value and the potential being offered by SOCO’s assets– both to investors and trade buyers.
SOCO is not a broken business, as its financials show. It’s just having big problems: oil reserves plunged dramatically, we were informed last week, and that caught the market off-guard.
Revenue and profits were down, but SOCO may manage to retain a decent free cash flow profile by cutting back on heavy investment. As it slashes capital expenditure, however, management also undermines the value of this growth story. SOCO is not an investment I am willing to take, and the track record of its management team plays a big part in it.
In this environment, I would not be surprised if the group announced a zero dividend policy by the end of the year.
Give Ophir A Pass: Too Much Risk Is Involved!
Since Ophir Energy announced its acquisition of Asian oil explorer Salamander Energy on 24 November, its shares have gone nowhere. At that time, the two oil explorers said that the all-stock deal had a “compelling strategic logic”, essentially pointing out that the shareholders of the resulting combined entity would be the ultimate winners — but will they?
In late 2014, many analysts predicted that Ophir would surge this year, yielding upside of at least 100%, based on its net worth. At 122p, the shares are down almost 20% year to date.
In truth, cash flow also matters in the calculation of fair value, and it doesn’t look like the high degree of uncertainty surrounding Ophir’s projects pipeline was taken into consideration. I doubt the integration of Salamander will prove to be a smooth process, either. Management said that “the combined business would have a strong balance sheet,” but financials show that it could be tough times ahead for shareholders.
Only a few months ago, and in spite of plunging oil prices, analysts were similarly optimistic about Afren.
According to its net worth, Afren’s stock was valued well above 100p. Afren currently trades around 3p, and although I believe Afren could end up being a fantastic restructuring play, its shareholders are now the obvious losers.
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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has recommended Afren. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.