A toxic combination of management corruption and the falling price of oil has driven Afren (LSE: AFR) shares down by 71% so far this year, to 47p, the lowest level since June 2009.
Many shareholders are probably feeling pretty unhappy: management corruption is always a nasty surprise, and has compounded the effect of the falling oil price.
Bargain valuation?
The independent report into the unauthorised payments made to former directors found that there was “no material loss” to Afren as a result of these transactions. Happily, the evidence we have seen so far suggests that the firm’s operations and the value of its assets have been unaffected by this scandal.
What’s more, analysts’ forecasts for Afren’s earnings have not fallen anywhere near as fast as the firm’s share price.
Although last week’s sudden fall in the price of oil is not yet fully reflected in earnings forecasts for the next couple of years, it’s worth noting that Afren now trades on a 2015 forecast P/E of just 4.
Even if we downgrade next year’s earnings by another 20%, that still leaves Afren shares trading on a forecast P/E of 5, which looks cheap to me.
Potential upside before Q2 2015?
It seems clear to me that if Afren manages to deliver 2014 earnings anywhere near current forecasts, then Afren’s share price could re-rate sharply. Similarly, any rebound in the oil price could lift Afren’s shares quite quickly.
However, it’s important for investors to consider how the firm’s operations and growth plans might be affected if oil prices remain at current levels.
Is Afren still profitable?
In my view, Afren’s operations should remain solidly profitable with oil at $70 per barrel: Afren’s results for the first nine months show that it generated net cash from operating activities of $454.8m on sales of $798.5m, suggesting production costs of around $40 per barrel.
However, it’s clear that next year’s profits will be lower, and I wouldn’t be surprised if the firm scales back some of its planned capital expenditure to prevent a cash crunch.
Is Afren a takeover target?
Afren currently trades at half its book value, despite the proven quality and cash generating potential of its assets.
As such, I wouldn’t be surprised to see a bid emerge in the next few months. One possible candidate is Nigerian shareholder South Atlantic Petroleum Limited, which has built a 7% stake in Afren so far this year.
