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Should I Invest In Afren Plc Now?

When the tide goes out, we see who’s swimming naked.

That’s something along the lines of a famous utterance by super-investor Warren Buffett. In the case of Nigeria-focused oil exploration and production company Afren (LSE: AFR), the price of oil represents the tide.

Running hot

The recent oil-price plunge pulled the rug from under Afren’s cash inflow in a disastrous way. Afren ran hot and geared up to the maximum to fund its operations and capital development projects. The firm drew down all its available lines of credit and careered forward at full throttle — exploring, discovering producing — the cash poured in, and then poured straight out again to service the interest on all the debt and to fund capital expenditure commitments.

When the oil price plummeted, suddenly the sums didn’t add up and Afren was in trouble. In a statement released on Tuesday 27 January, the firm said it needs equity funding in excess of its market capitalisation. That’s why the shares plunged down to around 7p today — it’s been quite a stomach-churning ride for investors since the shares touched 169p or so at the beginning of 2014.

Should I buy?

With the share price adjusted down for the refinancing, now seems like the perfect time to invest in Afren, right?  I’m not so sure. The directors say new funds will be required to meet interest and principal repayments, working capital and a reduced capital expenditure. What’s unclear is how the firm will fund ongoing working capital and capital expenditure after using up the raised funds. Will reduced cash flow from selling production at a lower oil price be enough without the drag of debt interest payments, or will the firm be tempted into raising new debt to fund capital expenditure in the future?

One possible saviour for Afren comes in the form of a firm called SEPLAT Petroleum Development Company. The two companies remain in discussion regarding a possible combination of some form. However, I’m not holding my breath on that one. With the extent of Afren’s financial woes fully exposed, there’s clear incentive for SEPLAT to drive a hard bargain, or even to walk away altogether.

Keep it simple

Investing is at its best when it’s at its simplest. The trouble with Afren right now is that the opportunity lacks visibility. Who knows what will happen next and what risks lurk ahead. The best value in shares is that which is face-slappingly obvious — that’s not Afren right now.

Given the extent of the trauma in the sector due to the fallen oil price, we have a lot of choice. Many robust firms are also well down from highs and they could make better investments from here. Do I really want to invest in a firm like Afren that has shown the past form of allowing itself to become riddled with the pox of debt and which has just demonstrated its financial fragility by collapsing just six months into a lower oil price environment? I think I’ll pass on this one.

Opportunity abounds on the London stock market, but going into high-risk situations such as Afren now may not be the best way to preserve capital. I'm trying to protect the downside first and one way of doing that is to think differently from other investors.

A special Motley Fool wealth report discusses that point as one of Ten Steps To Making A Million In The Market. This useful report is available free of charge and without obligation. To download a copy, click here.

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has recommended Afren. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.