2 bargain-basement shares to kick off 2017

Low valuations and improving prospects have these shares on my radar in 2017.

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2017 started out with a bang for UK equities as the FTSE 100 index raced to a record high on the New Year’s first day of trading. But with valuations across UK indices also stretching to dramatic heights, bargains are becoming tougher and tougher to find for we investors. That doesn’t mean they can’t be found though.

One share trading at a bargain basement 5.6 times forward earnings that has caught my eye is Middle Eastern oil & gas vessel operator Gulf Marine Services (LSE: GMS). AIM-listed GMS builds, owns and operates a fleet of support vessels that anchor next to oil & gas platforms allowing workers to build, operate and decommission platforms in up to 80m of water.

Why are shares so cheap? There’s the expected and obvious answer of low oil & gas prices, but the larger issue is that GMS also has to contend with an expected $395m of year-end net debt that dwarfs the company’s £170m market cap.

Scary… or not?

This is a frightening statistic, but I believe the actual situation is better than it appears on the surface. First off, this debt doesn’t come due until 2021, giving it plenty of time to recover. Second, 70% of the revenue GMS receives is from opex activities rather than capex, which means a fairly reliable revenue stream over the long term. In addition, this debt pile is due to peak at year-end and then begin falling as the company’s ambitious new fleet expansion finishes in Q4 of 2016.

Furthermore, its business is relatively high margin and kicks off considerable cash. In H1 of 2016 operations generated $63.9m of cash from $110m of revenue. Now, if this is to continue GMS will need to see oil prices rise so that soon-to-expire contract are renewed. Thankfully, we’re seeing this as shares rocketed over 17% on Tuesday after the company disclosed a new contract win and a two-thirds rise in order backlog since November. While GMS has plenty of upside there are undoubtedly also high risks, but I reckon hardy contrarian investors may find the company worth a closer look in 2017.

Another share I find intriguing in the New Year is Middle Eastern oil services provider Petrofac (LSE: PFC). Its shares trade hands at 11.6 times forward earnings while also offering a 6% dividend yield. Like GMS, I’m attracted to it because it offers much of the upside of exposure to the oil & gas industry while removing much of the downside through reliable contracts from Middle Eastern national oil companies. Providing services that are always needed and bring fairly high margins means it also generates significant cash from operations, in this case $205m in H1 2016.

Now, Petrofac shares are unlikely to skyrocket any time soon unless oil prices also make considerable headway and drag margins back to their pre-crash levels. However, with only $900m of net debt, strong cash generation and a steady backlog of orders providing revenue visibility for years to come, I view it as a solid income option trading at a decent valuation.

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.

Ian Pierce has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Petrofac. 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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