With the resources sector having endured a very challenging period, many investors may be seeking out bargains at the present time. After all, the prices of a number of oil and mining companies have fallen dramatically and there could be opportunities to buy them at well below their intrinsic values.
Of course, there are major risks involved in buying shares in companies which have relatively downbeat near term prospects. Investor sentiment could worsen in the coming months – especially since there is no sign of a sustained rise in commodity prices being just around the corner.
And, even if commodity prices do rise, the current downturn could have permanently shifted the market’s view on the energy sector. In other words, even if oil rises to over $75 per barrel, valuations may take time to recover as investors price in a potential return to a lower oil price environment further down the line.
Within this context, a number of oil and gas companies are struggling in both a financial sense and also with regard to their share prices. For example, Gulf Keystone Petroleum (LSE: GKP) has delivered a fall in its valuation of 75% in the last year and has struggled to convince the market that its cash flow is sufficient to survive further difficulties in the long run.
This situation, though, could be about to improve since Gulf Keystone Petroleum has received three consecutive payments for oil exports from the Kurdistan Regional Government (KRG). This is significant and should help to alleviate the company’s cash flow headache, while optimism for further payments in 2016 is now much stronger. And, with Gulf Keystone having an excellent asset base which could deliver a significant amount of profitability in the long run, it clearly has huge potential.
The problem, though, is the significant risk posed by political instability within the Iraq/Kurdistan region. This, plus a low oil price and liquidity risk resulting from slow (or non) payment for oil exports next year, mean that Gulf Keystone is a stock to watch rather than buy at the present time.
Also enduring a very challenging period is IGAS Energy (LSE: IGAS). It recently reported a loss-making first half of the year, with impairments and goodwill charges having a hugely negative impact on its financial performance. And, with revenue halving versus the first half of the prior year mainly as a result of the lower oil price, IGAS has been forced to cut costs in an effort to boost its financial outlook.
In fact, IGAS has now completed its cost-cutting programme and has reduced its cost per barrel by 19% to $31. This should allow it to post improving profitability over the medium term, with IGAS expected to report a pretax profit of £3m next year. This would represent a major improvement on last year’s £18m loss, although further impairments and goodwill charges could still place and push IGAS’s bottom line into the red.
While IGAS has a large amount of potential and now trades on a price to book value (P/B) ratio of just 0.4, in the short term its shares could come under further pressure due to a challenging near-term financial outlook. As such, it appears to be a stock for the watch list rather than a company to pile into at the present time.
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Peter Stephens 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.