Investing in companies that have been abandoned by most other investors is risky. But such stocks sometimes recover and can be profitable investments.
Today I’m going to look at two stocks which were once popular, but have hit troubled times. Do either of them offer the value needed to stage a strong comeback?
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Cheap oil = cash
Since completing last year’s refinancing, Kurdistan oil pioneer Gulf Keystone Petroleum (LSE: GKP) has performed surprisingly well, despite the political problems in Iraq and Kurdistan.
Friday’s operating update confirmed that production is stable at more than 34,525 barrels of oil per day (bopd). The company’s oil exports to Turkey are continuing without interruption, with around 200 trucks loaded per day.
Best of all, the group has received regular payments for its oil and appears to be generating positive free cash flow. Gulf’s net cash balance has risen from $12m on 5 April to $47.2m in October, despite the company making $10m of interest payments during that time.
If it’s sustainable, this strong cash generation makes the stock look cheap to me. Based on the increase in the group’s net cash balance so far this year, I estimate that Gulf Keystone stock currently trades on a price/free cash flow ratio of about 5.
On sale at a discount
The company’s current market value prices its 360m barrels of net 2P reserves at less than $1 per barrel. That seems cheap to me, if you believe Gulf will be able to produce and receive payment for these barrels successfully.
Unfortunately, this isn’t certain, given the political and operational difficulties in the region. This risk is probably the main reason why — at 95p — the stock is trading at a 38% discount to its book value of 153p. I’d rate this firm as a speculative buy, but would only consider taking a small position.
An interesting turnaround
Sales rose slightly to £291.6m, but the group’s adjusted pre-tax profit fell from £11.5m last year to “£nil”. It’s an unusual result, but today’s share price rise suggests the market sees grounds for optimism.
One reason for this may be that a new management team has taken charge. Chairman Ron Series and chief executive Lloyd Dunn have a lot of industry experience, including the successful turnaround of Tuffnells, which they sold to Connect Group.
DX has also managed to secure a new £24m convertible loan. This will be used to refinance the firm’s operations and fund necessary restructuring and investment. Shareholders should note that this loan is convertible into shares at 10p each. Based on today’s market cap of £25m, this means that existing shareholders could face dilution of up to 50% if the group’s lenders choose to convert their loan notes into shares.
This dilution risk may be one reason why the shares currently trade on a 2018 forecast P/E of 7. If the loan was fully converted, this forecast P/E would rise to 14.
Despite this dilution risk, I believe DX could have turnaround potential. Although I wouldn’t want to pay much more than 10p-12p per share, I think the shares could be worth a closer look.