China is pulling out all the stops to boost its economy, which is good news for companies in the oil business, I’d argue — but just how good is it for the shareholders of SOCO (LSE: SIA), Xcite Energy (LSE: XEL) and Petrofac (LSE: PFC)?
Their fortunes are intimately tied to the price of the black gold, but also hinge on a few other elements.
Oil Prices
“Oil prices rose on Thursday as lower US crude stocks and optimistic global demand projections overrode concerns about a glut of supply,” Reuters reported today.
“Benchmark North Sea Brent crude oil was up 60 cents at $50.26 a barrel by 0855 GMT. US crude was trading at $43.50 per barrel, up 20 cents,” it added.
Oil prices are very low indeed, but the headline story is that oil prices have been stuck slightly above these levels since the turn of the year. Ever since, the shares of SOCO and Xcite have lost 50% and 13% of value, respectively, while those of Petrofac are up by 19%.
Petrofac Is Undervalued
Today you can buy shares in Petrofac at 16x its forward earnings, but if market consensus estimates are right, you might enjoy a significant upside over the next couple of years, given that this oil services group is expected to grow earnings per share (EPS) at a terrific compound annual growth rate of 67% over the next three years. That’s because EPS dropped significantly in 2014, when net earnings bottomed out, in my view.
Net debt of $1.2bn is manageable, even assuming that Petrofac will deliver adjusted operating cash flow (AOCF) of only half a billion dollars this year, which is a worst-case scenario at current oil prices. Most likely, its AOCF will hover around $700m-$800m.
Here’s another reason to take some risk right now: “Net profit (is) expected to be significantly weighted towards 2H 2015, reflecting phasing of project delivery, particularly in OEC, where a number of projects are expected to reach their percentage of completion threshold for initial profit recognition in 2H 2015,” Petrofac said in its latest trading update.
Its interim results for the six months ending 30 June 2015 are due on 25 August. You’d do well to buy its shares before then!
Xcite Is Hard To Value
Well, it takes a huge leap of faith to invest in Xcite in the current environment, simply because so many things could go wrong before the company starts generating revenues and cash flows to meet its debt obligations.
That’s not say that you may not record outstanding returns if you invest, but you must be ready to embrace a certain amount of risk that can’t be modelled at present time. Among other risks, its net debt position signals that a rights issue should not be ruled out.
Finally, we have no trading multiples and/or key financial metrics to gauge this risky equity, and although its business pipeline is promising, I’m not prepared to invest in its shares according to a top-down approach, either.
SOCO Is Not Cheap Enough
SOCO is a different beast, but also doesn’t strike me as being the most obvious oil play in this market. Its stock is about 20% more expensive than that of Petrofac based on forward net earnings multiples, but is 40% cheaper than Petrofac based on AOCF multiples.
Admittedly, these valuation metrics don’t provide much help, so I looked for a better gauge of risk, checking out the value of the current assets of both Soco and Petrofac — these are items that can be easily converted into cash, usually in less than a year.
The current assets of SOCO amount to 30% of its market cap, while Petrofac’s current assets are higher than its $4.4bn market cap. Petrofac is by far the safer choice, and that becomes evident when you take into account SOCO’s price to book ratio, cash flow metrics and returns — all of which signal stress, in my view.
Furthermore, I need more evidence that its management team can turn things around.
“Based on trading multiples and the fair value of its assets, downside could be 25% to 136.5p from 182p, where the shares currently trade,” I said on 17 April.
Its stock currently trades at 143p, and I’d still avoid it.
