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A UK penny stock I’d buy with my new ISA allowance

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I’m keen to buy some UK penny stocks. Now the ISA allowance has reset, I can invest as much as £20k this year and shelter from tax any gains on my investments.

A UK penny stock with potential

Oil & gas production and exploration company Pharos Energy (LSE: PHAR) released its full-year results report today.  The company has operations in Egypt, Vietnam and Israel. But 2020 wasn’t kind to the business because of the pandemic and the collapse of the oil price.

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Revenue declined by just over 25% compared to the 2019 figure. And Pharos posted a big loss rather than profits because of a mammoth impairment charge “as a result of the oil price volatility and movements in 2P reserves.”

In years gone by, Pharos (then called Soco) used to generate loads of cash and pay generous shareholder dividends. However, net cash from operations plunged by 22% in 2020 and the company even raised just under £12m in a placing in January to fund phase 1B of its waterflood programme in Egypt.

Other measures to preserve cash include the directors taking a 50% remuneration cut from 1 April  — I hope they weren’t just fooling when they said that! And there’s no shareholder dividend.

However, we can’t blame the pandemic for everything. Pharos has struggled to maintain its profitability for some time. And the share price shrank from somewhere over 400p in August 2014 to just above 23p today. Perhaps one positive is the valuation looks undemanding by some measures. For example, the price-to-tangible book value runs near 0.6.

Operational progress

In the report, president and chief executive Ed Story pointed to some positives. For example, production was in line with previous guidance. And the company received an extension to its TGT and CNV licences in Vietnam. In the third quarter of 2021, Pharos plans to start drilling in accordance with its TGT Full Field Development Plan. And that plan secured final approval during 2020.

Story said the operations in Vietnam have the lowest breakeven in the firm’s portfolio. And that means investments there have a quick payback time. On top of that, the drilling programme will be fully self-funded from the operating cash flows generated in the country. And the company expects to achieve post-capex free cash flow in the first half of 2022.

In Egypt, Story reckons reserves have been “significantly” upgraded. And the waterflood programme has begun.  Meanwhile, Pharos is “well advanced” in its search for the “right” farm-out partner to invest in the project.

When a UK penny stock has been performing as poorly as Pharos has for so long, it takes a leap of faith to embrace the forward-looking operational potential. But I reckon the outlook’s positive and the shares may be worth holding now.

However, today’s stock price around 23p is well up from the lows last autumn near 10p. And the business operates in a cyclical industry with much of the trading outcome dependant on oil prices, which is outside the directors’ control.

These shares come with many risks, but I’m tempted to tuck a few away for the long-term recovery and growth potential of the underlying business.

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.