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Why I’d Steer Clear Of Afren plc But Buy Amerisur Resources plc

Since I started writing for The Motley Fool, I have covered several companies. Today, I revisit Afren (LSE: AFR) and Amerisur Resources (LSE: AMER). I’m checking back in with both of these oil producers to take a fresh look to see whether my views should change for the better, or, indeed the worse.

The rationale behind this approach serves to make sure that I don’t lose sight of any companies that interest me, and help me to gauge whether my analysis has been accurate, or otherwise.

So while I haven’t directly compared Afren and Amerisur before, I felt like now was as good a time as ever, especially as both companies have released news recently.

Afren – Debt Becomes Her…

The last time I wrote about this company, the shares were trading at nearly double the price that they are currently. Whilst the shares remain volatile, I would urge caution for any investor who thinks that they are currently cheap – here’s three reasons why:

  • Debt – if anything can kill a company, it is debt. Sadly, Afren has no shortage of it. As we head towards the company restructuring, and assuming that the open offer is taken up in full, the company will still have well in excess of £1 billion pounds of debt. Rather unsurprisingly, the bondholders are not giving Afren their best rate, either, with the 2019 and 2020 loan notes yielding over 9%. Shareholders in my view are currently at the mercy of the bondholders, and bondholders are not known for their generosity! This is currently strangling the company; sadly, I expect the situation to get worse.
  • Known unknowns – additionally, the company tells us that there is a number of claims against the company. There is one for over $104 million from West African Ventures in termination and cancellation fees, costs, losses and expenses under oil services contracts. Another by Lion Petroleum for US$10 million in damages plus costs in respect of certain breaches of the JOA signed between East African Exploration (Kenya) Limited and Lion Petroleum in respect of Block 1, Kenya. Finally, there is another with Amni, where the potential cost cannot be quantified.
  • Working Capital – in the prospectus, the company tells investors that it doesn’t believe that it has enough working capital for twelve months of operations.

Any one of the above issues should make investors nervous, especially as they are being asked to hand over more cash under the open offer.

Amerisur – No Longer A Pipe Dream…

With a market cap of around £400 million, Amerisur is the 559th largest company in the UK. It is an independent oil and gas production and exploration company focused on South America. It owns assets in Colombia and Paraguay, where it operates and holds a 100% working interest in the Platanillo block in Colombia. The 11,048 hectare block is located in the Putumayo Basin, in the south of Colombia. It operates and holds 60% working interest in Putumayo-12, a 54,444 Hectare block which is adjacent to Platanillo. The company also holds 100% of the Fenix block, a 24,117 hectare area in the Middle Magdalena Basin of Colombia.

It holds 100% ownership of five blocks, holding two exploration and production and three prospecting permits extending over 6.4mm hectares. That adds up to proven and probable (2P) commercially viable oil reserves in the region stand at 24.5 million barrels, worth nearly $1.5bn at current prices. In addition, the oil-rich fields in which it operates allows it to take oil out of the ground very cheaply, and profitably, even with the black gold substantially cheaper than this time last year, something that other operators have struggled to do. Indeed, some have been forced into the red as oil prices plunged – Afren being one of them.

On 12 June this year, shares in Amerisur jumped on news that a deal with Petroamazonas, Amerisur’s new pipeline partner, had been reached. Petroamazonas is the company that operates the Amazonas pipeline network in Ecuador, and this deal will allow Amerisur to build a pipeline from the Ecuadorian border to the Amazonas pipeline network – the work can start immediately.

The company already has permission from the Colombian government to build the interconnecting pipeline between the Platanillo oil fields and into Ecuador. Investors are now waiting on the environmental permission from the Ecuadorian government — management expects that this will be approved in due course. If the green light is given, the pipeline will run underneath the Putumayo River.

For me, if all goes well and the permissions are granted, investors could well see an upward re-rating of the shares as the pipeline will substantially reduce operating expenses and give, potentially significant production growth optionality. It is hoped that everything will be in place in the last quarter of this year.

Final Thought…

Here we have two oil explorers that to my mind are heading in very different directions. The chart illustrates this rather well.

 

It is true that some traders will make their fortune by getting the call correct and trading in and out of Afren as a vast amount of new shares are issued, and some who could find that they have lost their shirts.

For long term investors, even with oil at these prices, I think that Amerisur is the better play.

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