Sound Oil (LSE: SOU) is down 12% at the of writing following its two latest updates, which were released today. Here are a few elements you should consider before either buying or selling into its shares.
Today’s First Update
As upstream oil and gas company with a market cap of almost £100m and operations in the Mediterranean area, Sound Oil certainly deserves attention, given that it is expected to report fast-rising earnings over the medium term. It’s also attractive because following a recent placement it seems to be well funded, as its balance sheet shows. It said today that it had entered into a farm-in agreement “with the Moroccan Oil and Gas Investment Fund in relation to the Tendrara licence, onshore Morocco“.
There’s “exploration upside” here, at least according to Sound Oil, which will acquire, upon completion, a 55% working interest in Tendrara. Under the terms of the agreement, Sound Oil will pay the full cost of the three wells, of which “only the first well would be a firm commitment“. The drilling of the first well is expected to cost about £6 million, and will commence in Q4 2015 — the commitment to fund the second and third wells will depend upon the results of the first well.
All good here: there’s risk, but the explorer could generate some cash flow sooner than expected, and is funded, so its plan makes sense.
The onshore Tendrara licence includes two stranded gas discoveries with “low risk appraisal potential and significant blue sky exploration upside,” the group said, adding that preliminary internal estimates of existing discovery volumes “are broadly comparable to estimated volumes (post a successful drill) at the company’s Badile licence in Italy“.
Nervesa Gas Discovery Update
The second appraisal well at the Nervesa discovery in Italy isn’t faring as investors expected, and here’s where things get a bit more complicated.
“As announced on 20 May 2015, the company identified gas shows in multiple intervals in the Upper Miocene San Dona Formation. It has now successfully perforated and completed seven intervals in the lower section of the reservoir where the most significant gas shows were identified.“
What does this mean, really?
As initially feared, Sound Oil confirmed that initial gas flows have identified that “multiple perforated intervals (between 1929 and 1988 metres depth) are indeed gas bearing, but are however of relatively low permeability“.
Performance
Well, then delays become inevitable, with clean-up operations set to follow, and only later Sound Oil will decide whether to initiate “a well test directly or to utilise stimulation techniques beforehand“.
Investors were not pleased with its key Nervesa update, but should you really give it a pass at its current price? On the one hand, at 17.8p a share Sound Oil has lost 30% of value since 5 May. On the other, it currently trades in line with its 52-week median, which suggests that investors are not entirely sure about what the next update may bring.
Finally, consider that its implied earnings multiple stands over 30x, on a forward basis, which is not a prohibited valuation, if Sound Oil delivers — but then there’s no dividend attached to the stock, which has already risen more than 50% this year.
