Will this energy stock outperform Tullow Oil plc?

Should you buy this energy play instead of larger sector peer Tullow Oil plc (LON: TLW)?

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Sound Energy (LSE: SOU) has released an upbeat half-year update that shows that it’s making positive progress and also gives us clues as to whether it’s a better buy than energy sector peer Tullow Oil (LSE: TLW).

Sound Energy’s first half included progress in its Moroccan and Italian operations. For example, in Morocco it made a significant gas discovery that has the potential for a multi Tcf connected gas field. The first well drilled at the Tendrara prospect encountered around 28 metres of net gas pay in the TAGI reservoir. Progress on the second well is encouraging and it was spud on 25 August with a view to proving a sub-horizontal drilling concept.

Progress has also been made by Sound Energy in Italy. The final Badile drilling permission was received in May and the first farmout was secured with Schlumberger. They will fund €7.5m of the first well at Badile in exchange for an option on 20% of the licence. And with Sound Energy having completed a group debt refinancing with the issue of five-year €28.8m bonds, its financial outlook is encouraging.

Clearly, this is a difficult period for energy stocks such as Sound Energy. The low oil price is expected to stay and while this can mean lower costs for drilling and exploration activities, it also reduces the net present value of potential projects. Still, Sound Energy has benefitted from improved investor sentiment this year and its shares have risen by 412% since the turn of the year.

More rises ahead?

This level of performance easily beats that of energy sector peer Tullow Oil. Its shares have risen by 27% in 2016, but there could be much more to come. That’s because Tullow is in the midst of a major ramp-up in production as a result of its TEN assets coming on-stream. They’re expected to positively catalyse Tullow’s earnings and increase its bottom line by 137% in the next financial year. This puts it on a price-to-earnings growth (PEG) ratio of just 0.2, which indicates that it offers significant upside potential.

This compares favourably to Sound Energy’s near-term earnings outlook. It’s expected to remain lossmaking in the current year before delivering a black bottom line next year. However, Sound Energy trades on a forward price-to-earnings (P/E) ratio of 132 and this indicates that following its share price gains this year, its shares may be fully valued. Certainly, Tullow’s forward P/E ratio of 17.6 is hardly cheap, but it offers significantly better value than Sound Energy.

Of course, Sound Energy is focused on exploration and therefore its financial performance may improve dramatically in the long run. However, with the outlook for oil being uncertain it may be prudent to focus on companies that are cheaper and that offer clear growth potential over the short-to-medium term. Due to it offering superior appeal on both these counts, I believe Tullow Oil is a better buy than Sound Oil at the present time.

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.

Peter Stephens has no position in any shares mentioned. 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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