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One turnaround stock I’d sell to buy Hurricane Energy plc

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Silhouette of an oil rig
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South African gold miner Pan African Resources (LSE: PAF) has lost 50% of its value over the last year. The group’s shares now trade in line with their book value and on a forecast P/E of 5.

This could be a stunning turnaround investment, as gold market conditions are quite favourable at the moment. But today’s half-year results suggest to me that caution might be wise.

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Operational challenges at the group’s Barberton Mines caused gold production to fall by 7% to 85,282 ounces during the six months to 31 December. Guidance for full-year production has now been cut by around 6% to 177,000-181,000 ounces, down from 190,000 ounces previously.

Performance has also been affected by industrial action and by the strength of the South African Rand (ZAR) against the US dollar. This is important because gold is traded in US dollars, but costs are in local currency. A stronger ZAR means that gold sales bring in less local currency, increasing the group’s cash mining costs.

Profits down 74%

The impact of these challenges caused Pan African’s H1 net profit to fall by 74% to just £3.6m. The group’s all-in sustaining cost of mining rose by 17% to $1,268 per ounce. That’s uncomfortably close to the current market price of gold, which is about $1,329 per ounce.

Chief executive Cobus Loots said today that the impact of the ZAR/USD exchange rate means that the group will have to “review higher-cost mining operations”. This could result in further production cuts or one-off costs from restructuring.

It could get better

I wouldn’t write off Pan African just yet. Management expects improvements in production levels and cost savings over the next six months. But the problem for me is that there are just too many unknowns. I’m going to stay away for now.

One stock I’d buy and hold

I don’t normally view small-cap commodity stocks as buy-and-hold investments. But I believe Hurricane Energy (LSE: HUR) could be an exception.

The group now has recognised resources of 2.6bn barrels of oil equivalent. So far, most of these are classified as contingent resources, which means they are known to exist but have not been shown to be commercially viable.

At the moment, Hurricane’s commercial reserves are limited to 37.3m barrels of oil in the Lancaster field. These are being targeted by the Early Production System, which is expected to begin producing in 2019.

However, if the group is able to convert some of these 2.6bn barrels of resources into reserves, then I believe the value of the company could multiply from current levels.

Good timing

It’s worth noting that Hurricane chief executive Dr Bob Trice is playing a long game here. Rather than selling a stake in the Lancaster discovery to raise funds to begin production, he’s gone to the market and raised $520m of fresh debt and equity.

In doing so, he attracted significant investment from oil industry specialist investors, such as Kerogen Capital. The North Sea is attracting a lot of fresh investment at the moment, and if Dr Trice can convert more of Lancaster’s 523m barrels of resources into reserves, Hurricane’s valuation could rise sharply.

In my view, the shares are probably quite cheap at current levels. It could make sense to buy a few today and tuck them away for a few years.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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