Many stocks look expensive after a 200% gain. But the companies I’ve chosen today still seem cheap to me, even though they’ve three-bagged over the last couple of years.
Profit from market caution
Small-cap North Sea oil producer Serica Energy (LSE: SQZ) has risen by 200% since last September. This surge followed the news that the company had agreed to use some of its cash pile to buy three mature, producing North Sea oil fields from supermajor BP.
The Bruce, Keith and Rhum (BKR) fields will add 50m barrels of oil equivalent to Serica’s reserves. They’re expected to increase the group’s net production to 21,000 barrels per day. The resulting cash flow is expected to lift the group’s profits from $10.8m in 2017 to $83.4m in 2018.
However, the share price doesn’t yet reflect these gains. Serica stock currently trades on a 2018 forecast P/E of 3. It’s clear that investors aren’t yet willing to credit the firm’s transformation.
Two risks
The first risk facing Serica is that production from its only producing field is currently stopped due to a pipeline blockage.
Output from the Erskine field was cut off in January, during cleaning operations. According to an update today, a small gap has been opened up, but service has not yet resumed. In the meantime, the group must be losing money.
A second risk is that the BP transaction isn’t expected to complete until the third quarter of 2018. Although the deal will be backdated to 1 January, the company won’t receive any cash from the BKR fields until late this year.
I don’t see either of these risks as a major concern. Serica reported net cash of $30.7m at the mid-point of last year and should be able to ride out any short-term losses. I believe the shares could double again over the next 18 months.
More of the same, please
Yesterday’s final results from mid-cap oil and gas firm Premier Oil (LSE: PMO) received a fairly positive reception from the market. The group’s stock — which I own — has tripled from the lows seen in January 2016, but continues to offer good value in my view.
I’ve recently bought more of these shares because I don’t think the 71p price reflects all of the progress that’s likely over the next 18 months.
The first area of improvement is debt reduction. Yesterday’s results showed a marginal fall in net debt to $2,724.2m in 2017. But the firm also released details of bond redemptions which lead me to think that this net debt figure could already be around $200m lower, at about $2.5bn.
Debt reduction is expected to speed up in the second half of this year, as production from the Catcher field reaches full capacity. In the meantime, I think some of the company’s undeveloped assets could attract outside interest.
Funding has already been agreed to develop the Tolmount gas field, which is targeting 540 billion cubic feet of gas resources. But Premier also has last year’s “world class” Zama oil discovery in offshore Mexico and the Sea Lion field in the Falkland Islands.
The stock currently trades on a 2018 forecast P/E of 6, reflecting its high debt burden. But as borrowings fall and progress is made with new projects, I expect the shares to rise significantly from current levels.
