Over the past two years, shares in small-cap oil explorer 88 Energy (LSE: 88E) have slumped by 61%, as a company has struggled to impress investors.
Today, I’m looking at another company that has managed to impress investors, and its returns over the past three years leave 88E trailing.
The comeback kid
During the first few years of the last decade, it was touch and go for steel producer Severfield (LSE: SFR). Losses spiralled and only a gigantic rights issues stopped the bleeding. Since then, management has been working flat out to restore the business to profitability and put it on a stable growth footing.
And it’s succeeded. Severfield has reported a profit for the last five years and, with revenues up by around 40% since 2015, the City expects earnings to continue to expand for the next two years. Analysts have pencilled in earnings per share (EPS) growth of 9.2% for fiscal 2019, followed by an increase of 8.6% for the following financial year.
In comparison, the City is only forecasting losses for 88E for the next few years. This is primarily because the company isn’t generating any revenue and, as its exploration plans struggles, it’s unlikely to see any income any time soon.
Therefore, it’s no surprise Severfield has outperformed 88E by 93%, excluding dividends, over the past two years.
Missing oil
88E is the perfect example of how tricky the oil business can be. Only last year, the company was riding high on the belief that its Icewine project, covering some 690,000 gross acres, could contain as much as 3.6bn barrels of oil. But after months of testing, in July the firm suspended operations at its Icewine#2 well where, despite trying different techniques to stimulate production, a 28-day testing period in June only produced 1,372 barrels of stimulation fluid. Although an amount of gas was also produced, that critical ingredient, oil, was missing.
The group has now moved on to the Winx prospect on Alaska’s North Slope where it may yet stumble across a vast oil reserve, although I’m not holding my breath. Oil exploration is notoriously difficult and unpredictable. Personally, I would rather invest in a company that has a brighter outlook and is already producing income for investors.
That’s why I’d buy Severfield over 88E any day. Unlike 88E, it’s also easy to place a value on the steel producer’s shares.
Cheap growth
Based on current City growth expectations, Severfield is currently worth 11.4 times forward earnings. This is hardly cheap, but it doesn’t take into account the £33m of cash on Severfield’s balance sheet. Strip out these funds (worth approximately 10.6p per share) and the stock is trading at a forward P/E of 10, falling to 9.1 for 2020.
In my opinion, this is far too cheap for a cash-rich business with EPS set to grow at a high single-digit rate. For income seekers, there’s also a dividend yield of 3.7% on offer, and the payout is covered 2.4 times by EPS.
