This year has seen a dramatic improvement in oil market conditions. But with the price of oil stuck in the mid-$50s, a full recovery is not yet in place. Most of the world’s biggest producers need to see an oil price of at least $60 per barrel to hit their financial targets.
This means that mid-cap companies who depend on the oil majors for business are still under pressure. In today’s article I’m going to focus on two high quality firms which I believe could outperform expectations as the oil market continues to recover.
How cheap is this quality stock?
Specialist chemicals group Elementis (LSE: ELM) has suffered from a downturn in sales to US drilling operators. The firm said today that pre-tax profits fell by 22% to $89.7m last year. One of the main reasons for this decline was a 16% fall in energy sector sales.
Elementis warned that the outlook remained uncertain, but to my eye today’s results contained a number of bright spots. The group retained its strong balance sheet, ending the year with $77m of free cash.
Trading also improved as the year progressed. Energy sector sales rose by 15% during the second half of last year, while sales in the Personal Care division rose by 23% during the same period. Elementis is currently in the process of acquiring antiperspirant group SummitReheis, which should drive further growth in this area.
Big upside
The group’s operating margin fell from 18% to 14% last year. But if trading continues to improve in line with the performance seen during the second half of last year, I’d expect margins to rise. Profit forecasts could rise if this happens.
Elementis shares trade on a P/E of 20, with an ordinary dividend yield of 2.3%. That doesn’t look cheap, but I believe this specialist firm could easily beat market expectations over the next couple of years. It remains worth buying, in my opinion.
A top oil pick for 2017?
Shares of oil services firm John Wood Group (LSE: WG) have fallen by 15% so far this year. The group’s recent results didn’t help. Management issued a downbeat statement warning of a “cautious near-term outlook” and “challenging conditions” in the North Sea.
But although Wood Group is known as a North Sea business, the group generated about 42% of its revenue in the US and Canada last year. It reported “early signs of improvement” in the US onshore market, where drilling rig counts are starting to rise. The firm is also targeting new business in Asia and the Middle East, where it believes “the greatest opportunities” will lie in 2017.
Although Wood Group’s operating margins have fallen as a result of the oil market downturn, they haven’t collapsed. Its adjusted operating margin fell from 8% to 7.4% last year, which is still very respectable.
Net debt remains low at $349m, and I estimate the group’s dividend should be covered by both earnings and free cash flow this year. The stock currently trades on a forecast P/E of 16, with a prospective yield of 3.7%. I think Wood Group could easily beat expectations from current levels. I’d rate this stock as a buy for income and growth.
