At the present time, many investors are shying away from investing in the oil sector. That’s understandable, since the near-term outlook for the commodity is not exactly positive, with a global glut of supply and relatively low demand combining to suppress the price of oil. Certainly, there is scope for further falls and, interestingly, very few commentators or industry experts have been right up to this point, with forecasts for the future oil price being decidedly uncertain.
Margin Of Safety
However, as with the price fall of any asset, the market seems to have priced in a rather large margin of safety. In other words, a number of oil companies are now trading on relatively appealing valuations due to the uncertainty regarding their future levels of profitability. Certainly, another prolonged fall in the price of oil is likely to mean further share price weakness, but it appears as though a fall of sorts is already being accounted for in the share prices of a number of oil producers and oil support services companies.
For example, Petrofac (LSE: PFC) and Amec (LSE: AMFW) currently trade on hugely appealing valuations. In the case of Petrofac, it has a price to earnings (P/E) ratio of just 12.4, while Amec’s is even lower at 11.5. Both of these valuations compare favourably to the FTSE 100’s P/E ratio of around 16, and indicate that share price rises could lie ahead. That’s especially the case since both companies are forecast to return to bottom line growth next year, which makes such a wide discount to the index even more difficult to justify.
Loss-Making
Unlike Petrofac and Amec, a number of oil-focused stocks remain loss-making. And, if the price of oil does remain relatively low, then this situation could worse – especially as the effect of impairments can be particularly severe on the bottom line. For example, Cairn Energy (LSE: CNE) and UK Oil & Gas (LSE: UKOG) are currently in the red, although this has been the case for each of the last five years as they seek to commence significant production over the medium to long term.
However, the two companies have seen their share prices rise over the last year, with Cairn’s up 5% and UK Oil & Gas’ up 407%. This is due to their recent discoveries, with Cairn Energy’s share price reacting positively to a significant find off Senegal, while UK Oil & Gas has seen investor sentiment improve following its oil discovery near Gatwick airport. As such, even a relatively low oil price may not matter if the two companies continue to experience positive news flow.
Looking Ahead
While Petrofac and Amec offer excellent value for money and a wide margin of safety, UK Oil & Gas and Cairn remain highly dependent upon news flow in order to continue to post strong share price gains. As such, and while Petrofac and Amec remain excellent value investments, UK Oil & Gas and Cairn’s share prices may come under pressure in the short to medium term unless they are able to deliver more upbeat news flow, which makes them highly risky propositions. As a result, long term investors may be better off sticking to Petrofac and Amec for the time being.
