BG Group’s Greatest Weaknesses

When I think of gas and oil exploration and production company, and LNG specialist BG Group (LSE: BG), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.

1) Commodity pricing

Whichever angle you look at it, BG Group is not in control of the price it achieves for the product it produces. The going rate for oil and gas varies with the supply and demand pressures affecting the general market for such commodities. It’s the same for all commodity producers, of course, but that situation makes it hard for the company to plan strategically.

Imagine owning a chocolate bar factory but not being able to set the selling price for the confectionary that you produce. Instead, you just have to sell it at whatever price happens to prevail in the chocolate bar market on the day. There’s no knowing in advance whether the sale price achieved would cover the costs of producing the sugary treats. On that basis, would you be confident enough to put resources and capital into building another chocolate bar factory?

Lack of pricing power is one of the reasons commodity companies attract a discount P/E rating compared to some other types of business.

2) Cyclicality

Factor one leads to factor two. When demand for oil and gas rises and falls, perhaps with general economic cycles, companies like BG are affected in two ways. Firstly, the price obtained for the commodity produced can vary and, secondly, the value attributed to resource reserves discovered, but still in the ground, can vary thus affecting the firm’s net asset value.

The inevitable result is a fluctuating, or cyclical share price. That’s an important point to consider when investing in a company like BG. The firm has the financial power to generate good prospects for growth, such as the opportunity to expand its LNG operation selling to China, and further potential oil and gas strikes, but investors should evaluate those opportunities within the frame of the company’s cyclicality.

BG’s strategy is to focus on securing prospective frontier acreage and enter, on average, one new basin each year. A recent deal, which sees the company awarded new exploration acreage offshore Myanmar is typical.

What now?

Despite BG Group’s weaknesses I still think the firm looks attractive as part of a well-balanced portfolio.

I'm also considering five stalwarts outlined in a Motley Fool wealth report. The five firms each operate in well-defended operating niches with attractive economic characteristics.

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Kevin does not own shares in BG Group.