Why I think this small-cap stock could trash the BP share price

This small-cap oil stock looks much cheaper than BP plc (LON: BP) and yields 9%. Should you be buying?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Legendary growth investor Jim Slater once said that elephants don’t gallop. This was why he preferred to invest in smaller companies.

Mr Slater was right. But for most of us, who have limited time to research and manage our investments, I think it makes sense to hold a mixture of reliable elephants and smaller, more exciting stocks.

An elephant I’d buy

BP (LSE: BP) is a good example of the kind of elephant I like to own. The shares are unlikely to double. But in recent years, the company has shown how investors can benefit from investing in elephants.

The huge financial impact of the 2010 Deepwater Horizon disaster was followed by the 2015/16 oil market crash, which saw oil prices drop below $30 per barrel at one point. Despite these pressures, BP only missed three quarterly dividends in 2010 and didn’t cut its payment at all in 2015/16.

Today, the company has restructured its operations to be profitable at lower oil prices and is starting to focus on debt reduction.

Analysts expect BP to report underlying earnings of $0.53 per share for 2019 and pay a dividend of $0.40 per share. Although earnings cover for the dividend looks fairly slim, cash generation has improved over the last couple of years. I expect this payout to remain safe.

These forecasts price BP shares on 12 times forecast earnings, with a dividend yield of 6.4%. I rate this FTSE 100 giant highly as an income buy. But I don’t expect too much in the way of growth. For that, I think we need to look elsewhere.

This small-cap yields 9%

The next company I’m going to look at is SOCO International (LSE: SIA). This £250m oil and gas producer operates in the waters off the coast of Vietnam and at onshore oil fields in Egypt.

At the time of writing, SOCO shares offer a dividend yield of 9%. Such a high yield normally means that the shares are too cheap, or that a dividend cut is likely.

Personally, I think this stock could turn out to be a serious bargain at current levels. Group production is expected to reach about 13,000 barrels per day by the end of 2019. Production costs are low, at less than $10 per barrel. Historically, this has enabled the group to generate very high levels of free cash flow.

Using this week’s half-year accounts, my sums suggest that SOCO shares trade on just six times underlying free cash flow from the last 12 months. If this level of cash generation can be maintained, then I think the dividend should be safe. The payout might even rise.

At a last-seen price of 65p, these shares also trade at a 37% discount to the firm’s net tangible asset value of 103p per share.

This looks like a bargain. What’s the catch?

The main problem seems to be that growth has been limited in recent years and CEO Ed Story’s strategy is unclear. Is the business, which Mr Story founded, heading for a long-term decline?

A strategy day is being planned for City analysts in October. Hopefully we’ll find out more then. Until that time, I continue to feel that SOCO is a potential bargain for small cap investors.

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.

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.

More on Investing Articles

Young black colleagues high-fiving each other at work
Investing Articles

2 FTSE 100 value stocks I’d buy for my Stocks and Shares ISA in March!

Now could be a great time for fans of FTSE 100 value stocks to go investing. Here are a couple…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Looking for value stocks? Here’s 1 I’d buy and 1 I’d avoid!

This Fool delves deeper into two value stocks she’s had her eye on and explains why she’s bullish on one,…

Read more »

Young black woman using a mobile phone in a transport facility
Investing Articles

With the Airtel Africa share price in pennies, is it a bargain?

With the Airtel Africa share price having slumped by a quarter in just one month, this shareholder considers some of…

Read more »

Asian man looking concerned while studying paperwork at his desk in an office
Investing Articles

Are these 2 defensive FTSE 100 stocks shrewd buys after recent updates?

This Fool takes a closer look at these FTSE 100 stocks. She admires their defensive traits -- but does that…

Read more »

Portrait of elderly man wearing white denim shirt and glasses looking up with hand on chin. Thoughtful senior entrepreneur, studio shot against grey background.
Investing Articles

The FTSE 100 closes up after full-year results from leading UK firms – are they buys?

Earnings season brings about a lot of ups and downs for the FTSE 100. Yesterday had some particularly good releases,…

Read more »

artificial intelligence investing algorithms
Investing Articles

Should I buy NVIDIA stock as a British investor?

NVIDIA stock is up two-thirds this year alone. Our writer considers some pros and cons, specifically given that he is…

Read more »

Investing Articles

With £2,000 in excess savings, I’d buy 41 shares in this Warren Buffett dividend stock

Stephen Wright thinks one of the best dividend shares to buy right now might be a Warren Buffett stock that’s…

Read more »

Investing Articles

How many Aviva shares do I need to collect a £100 monthly income?

Aviva shares are well suited for passive income purposes. Our writer works out how many would be needed for a…

Read more »