Should I Buy Alkane Energy Plc Along With Royal Dutch Shell Plc?

Could Alkane Energy Plc (LON:ALK) make the ideal partner for Royal Dutch Shell Plc (LON:RDSB) in this Fool’s portfolio?

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Shares in small-cap electricity generator Alkane Energy (LSE: ALK) rose by 7% this morning, after the firm published its interim results.

Total power generated during the first half of the year rose by 25% to 106GWh, thanks to the 2014 acquisition of Alkane’s smaller peer, Carron Energy. Revenue climbed 23% to £8.7m, while adjusted pre-tax profit rose by 166% to £1.4m.

Adjusted earnings rose by 119% to 0.94p per share, putting the firm on track to deliver a winter-weighted full-year forecast figure of 3.2p per share. Even after today’s gains, this leaves Alkane shares trading on a modest forecast P/E of 7.5, with a prospective yield of 1.6%.

I think Alkane shares could be worth a closer look.

Hidden value?

Alkane’s business has two parts. It buys up leases to old coal mines and uses coal mine methane gas (CMM) to generate electricity. The firm is adding steadily to its CMM portfolio as opportunities arise.

The second part of Alkane’s business is providing power response capacity for the National Grid. A mixture of mains gas and CMM gas is used to generate electricity at short notice to meet peak demand. Alkane is paid premium rates for this electricity and the firm’s contract with the National Grid currently extends to 2025.

There’s also a third factor, which makes Alkane far more exciting than its core business suggests.

In June 2014, the firm transferred its shale gas interests to Egdon Resources in return for 40m Egdon shares, which are currently worth around £4.8m.

Egdon is the UK’s third-largest shale firm. If the shale industry ever takes off, Egdon shares could skyrocket. Owning Alkane shares could be a much safer way of gaining exposure to Egdon, since Alkane is profitable and has no financial commitments to Egdon or its former shale operations.

Alkane’s sales have risen steadily, from £6.3m in 2009, to £16m in 2014. Profits have kept pace too, rising from £1.4m in 2009 to £3.4m last year. Forecasts suggest that sales could rise to £21.7m in 2015, generating a profit of £5.1m.

I think Alkane could be a profitable buy for small-cap value investors, but I wouldn’t bet the farm on such a small company. A change in market conditions could alter Alkane’s outlook drastically.

One way of balancing this risk and generating a valuable dividend income would be to buy shares in Royal Dutch Shell (LSE: RDSB).

Shares in the UK’s largest listed company are currently trading at the lowest levels seen since the financial crisis. Shell’s prospective dividend yield has risen to 7.3%.

At these levels, a dividend cut is a risk, but as a shareholder I’m not too concerned. Shell’s giant balance sheet carries very little debt. The firm should be able to afford to subsidise the dividend for a couple of lean years without too many problems.

I suspect that Shell’s management will be very reluctant to cut the dividend unless oil market conditions get even worse. I don’t expect this to happen and believe that we could see the oil market bottom out over the next six months.

City analysts seem to agree. Broker forecasts for Shell’s 2015 and 2016 earnings have remained stable over the last month or two, after logging big falls earlier this year.

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.

Roland Head owns shares of Royal Dutch Shell. 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.

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