Buying shares in stocks which are experiencing challenging trading conditions is a risky strategy. It could mean paper losses for investors in the short run, since it can take time for an industry to offer improved operating conditions. However, when a company within that industry trades on an ultra-low valuation, it means there may be a higher chance of capital gains in the long run. Reporting on Thursday was a stock which has a low valuation that indicates over 50% capital growth could be on the horizon.
A difficult year
Oil & Gas support services company Hunting (LSE: HTG) saw its revenue decline from $810.5m in 2015 to just $455.8m in 2016. That’s a fall of 44% and this caused it to swing into an underlying EBITDA (earnings before interest, tax, depreciation and amortisation) loss of $48.9m. This was mostly caused by a lower oil price, which meant oil producers have less appetite for investment.
Despite the improved outlook for the oil price following OPEC’s decision to cut production, Hunting’s financial performance is set to remain disappointing. It is expected to report a loss in the current year, which means that investor sentiment could come under pressure. However, it continues to develop new product lines and has been able to help its customers to lower their operational costs and increase project efficiencies. This should help to strengthen the company’s competitive position in what is becoming an increasingly concentrated industry.
Due to the strategy it has adopted and the prospect of a higher oil price, Hunting is forecast to return to profitability in 2018. Clearly, there is scope for a downgrade to its outlook due to its dependence on the price of oil. However, since the company’s shares trade on a price-to-book (P/B) ratio of just 0.9, they seem to offer a wide margin of safety.
In fact, if Hunting is able to return to profit in 2018, its shares are likely to rise significantly. That’s due to a reduction in the prospects of asset writedowns, while it could also be argued an element of goodwill will be deserved since its assets are able to produce a profit. As such, a P/B ratio of 1.5 could easily be deserved, which would equate to a share price gain of over 50%.
Of course, an improving industry outlook means that other Oil & Gas support services companies could also be attractive places to invest. For example, Lamprell (LSE: LAM) is also expected to move from being a loss-making business to a profitable entity in 2018. This has the potential to improve investor sentiment – especially since it also trades at a discount to net asset value.
Lamprell’s P/B ratio is just 0.6, which is a third lower than that of Hunting. This suggests there is even greater upside potential on offer, which could make Lamprell an even more attractive investment. Like Hunting, it seems to have a sound strategy to not only cope with a lower oil price, but to also position itself for future growth through becoming a more resilient business. Therefore, while both companies could be star buys, Lamprell appears to have the most enticing risk/reward ratio.
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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.