Oil & Gas Watch - Serica Energy And JKX

9th Feb '21 by Jack Brumby

26 comments 8310 reads

The oil and gas industry is experienced in dealing with tough market conditions, but nobody could have predicted the confluence of events that have hit all businesses over the past year.

A severe and rapid crash in commodity prices due to oversupply combined with a simultaneous fall in demand as a result of lockdowns has smashed sentiment. And, longer term, there are those trends towards a greener future and less fossil fuels to consider.

But, given how badly these stocks were hit by Covid, and the fact that oil and gas prices have at least partially recovered, there could be some contrarian opportunities in this industry group.

The oil price has just passed $60 with some commentators such as Rystad Energy anticipating a recovery in 2021 demand. I’m as wary of forecasts as the next investor but I also think it’s important to be able to hear the mood music.

The fact is the oil and gas prices have rebounded from the 2020 lows:

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Source: Serica Energy Corporate Presentations

And yet some energy stocks seem to have underperformed base metals and the broader indexes in the second half of 2020 and into the new year.

What if we’ve passed ‘peak fear’ for oil and gas and prices continue to strengthen in 2021? While the longer term outlook is hardly a bed of roses given the committed shift to a cleaner energy mix, some stocks in the sector do look attractive on valuation grounds - especially those that have high quality management teams, solid cash generation, and proven profitable economics even at lower spot prices.

O&G stocks are risky as they are exposed to rising and falling commodity prices. They will never have the consistency of consumer defensive stocks, for example, and some might rule out the sector completely. It can be a low quality area of the market, with volatile profits and losses, and notable bankruptcy risks.

Taking the industry group and pruning the data of stocks that don’t have StockRanks confirms this impression. The below chart is from a sample of 106 oil and gas companies listed in the UK. Note how few winning styles there are.

18rLUjR1dXo4Yl6XL4sC2vWwKzG_WAGWqV1vU0g0zEBBpjYM9tcCqr9lNfS0sY3QACYoeUj49wLFysud-zs6z9dl6DYZFzHtu5vordmFaFUm43bubnx3_97Y10iyUX7A7iTY7WAL

And again, with the RiskRatings, the warning signs are there that this is a particularly speculative part of the market. There isn’t a single Conservative stock in the set, and…

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DVB99

9th Feb '21

I see see considerable value here, with higher oil & gas prices not yet fully reflected in share prices. Some of these companies will generate loads of cash in 2021.

I hold JKX, Enwell & Serica, Like all 3 a lot, as all have no/minimal debt.

davidallen77

I am Sdx Energy (LON:SDX) also recent small purchase after some bigger buys last week i think, dividend?

Branoc

Wentworth Resources (LON:WEN) popped up when I was going through screens the other day with a perfect Piotroski F score of 9. Keep meaning to circle back around and have a proper look so will keep an eye out for any thoughts you have Jack.

IncredibleMosesLeroy

Interesting stuff Jack, I'm wondering if anyone has considered a picks and shovels approach based on oil tanker shipping?

Teekay Tankers, who are one of the better companies in the space are trading on a P/B of 0.33. Gaslog, who move LNG, are trading on a P/B of 0.18 with a P/E of 1.8.

A variety of other tanker companies are trading at similarly low multiples with P/Bs varying from 0.5 to 0.12. Even if oil and gas is in decline long-term, I can't help but think that hydrocarbons will need to be moved around the world for some years yet.

A big part of that thinking is the constraints the Biden administration appears to be putting brakes on shale boom, which I think must help Gazprom (£OGZP), who regardless of the completion of Nord Stream 2 must be a beneficiary of the shale slowdown, and yet are trading at P/B to 0.38 and P/E of 2.7!

yellowdog

A couple of useful metrics for valuing O&G companies are the ratio $ EV/2P and the $ price per flowing barrel ( ppfb )

At the moment the average for +10,000 bopped companies is $8.2 boe EV/2P and $29.8k ppfb.

JKX is very cheap at $1.1 EV/ 2P and $9.3 ppfb

SQZ not so cheap but ok at $8.5 EV/2P but better $20.4 ppfb.

The figures change from day to day according to share price and EV but I think are correct at time of posting.

piersmahoney

£JKX Oil & Gas is a well established company and has been listed on the London Stock Exchange for more than 20 years. Over a period of 20 years, it's Price to Book Value has on average been 1.61 against a current valuation of 0.44. In addition, it's long term Price to Sales Ratio average has been 3.21, against its current ratio of 0.81. Therefore according my books, this is an undervalued company. Should these ratios revert to the mean, we can expect a substantial increase in price.

I hold (since summer 2020).

JohnEustace

I own DGOC. I was encouraged by the announcement of the JV with Oaktree Capital, taking that as a strong endorsement. Something they emphasise on their investor presentation is their ownership of their midstream pipeline and processing plant which gives them opportunities to maximise value.

Their yield is very attractive and I do think it will be maintained. But because they are planning to invest their own money alongside the $1bn from Oaktree they will have to raise funds. They are actively looking for opportunities and the Oaktree link lifts them up a league in the deals they can consider.

So on the one hand they will be paying dividends and the other raising money via debt or equity. They say that any new investments will have to support or strengthen the dividends and that this way of doing things is preferred by their US investors who became disillusioned with other sector companies who raised money and never gave anything back.

I think the Biden ban on new prospecting on federal land will raise the value of existing assets.

10th Feb '21

I should add that I think the bear points re DGOC relate to their accrual for end of well life decommissioning and cleanup costs. I assume extending the well life enables them to make different assumptions than the previous owners. In so far as this is done by real engineering as opposed to the financial kind thats fair.

I did note the terms of their JV with Oaktree leave the wells reverting to DGOC after Oaktree have earned their target returns. So Oaktree participate in the profits from the main well life and walk away from any end of life issues. DGOC get all the benefit and risk involved in extending the life of the wells after they take full ownership. So it will be some years before we get to see who has the smart side of that deal. Currently both parties seem happy.

Snowbum

Thanks for the write up Jack. I was looking at Serica briefly too recently, do you have any details/info on any decommissioning liabilities they may have exposure to?

Michael Taylor

Great write up, Jack.

Think this is a fair summary of both companies and the opportunity.

I hold JKX but wondering if I should be holding SQZ - was already looking at it and you have succinctly put everything in one article!

JKX not for widows and orphans but definite re-rating potential. Although there is also the potential for it to halve on one bad RNS.

I guess many stocks are like that but given the jurisdiction it operates in it's a real risk you need to be comfortable with.

Jack Brumby

Hi Forbsy,

I did take a look and noted management states one of SQZ's strengths to be its low decommissioning liability.

There is a c£23m provision on the balance sheet for it, and around £12m of SQZ's £100m cash position is in a restricted account for these liabilities.

Just scrolling through the half year update, I see this section regarding the BKR assets:

Non-current provisions of £22.8 million have been made in respect of decommissioning
liabilities for the Bruce and Keith interests acquired from Marubeni (31 December 2019:
£22.6 million).

These were not subject to the same deferred consideration arrangements as those field interests acquired from BP, Total E&P and BHP respectively under which decommissioning liabilities were retained by the vendors with Serica liable to pay deferred consideration equivalent to 30% of the actual costs of decommissioning net of tax recovered by them. No provision is included for decommissioning liabilities related to the Erskine facilities as these are retained by BP up to a cap which is not projected to be exceeded.

So a good chunk of the decommissioning liabilities fall to the vendors of the BKR assets (although new extensions made by SQZ will have to be handled by SQZ), with SQZ to pay net 30% of actual costs. Note 24 in the 2019 Annual Report provides a bit more colour/detail.

Erskine - Serica’s share of decommissioning costs here will be met by BP up to a level of £31.3 million, adjusted for inflation, and Serica thinks costs are below this level.

A more detailed look was beyond the scope of this article but it's definitely an important point, and something I would want to dig into for a longer piece on the company. On the whole, given the £100m net cash position, it looks manageable - but still a liability for people to be aware of.

cmpeckham

I hold a number of small O&G stocks, some oilers (but particularly gasers) for various reasons:

- It's a totally unloved sector which will still be churning out the $ for a long while yet, despite long term decline.
- I have a fair amount in renewables related names that O&G names provide some hedge against.
- They provide an inflation hedge with yield.
- I ended up with a decent position in RockRose that I didn't want to move out of the sector entirely in one go, so was willing to accept smaller positions across a group that I considered second best.

gwilli68

You might be interested in £DCC . It's involved in LPG and Oil, but also diversified into Tech and Healthcare. Id be lying if I said Id fully got my head around everything that it does but Im working on it and so far it certainly seems reasonably priced.

jules2k6

11th Feb '21

I hold Touchstone Exploration Inc (LON:TXP) which has done quite well recently. It was bought based on earnings growth a couple of months ago.

Compare and contrast.

Kistos - the new Rock Rose ( Andrew Austin ) Mkt Cap £66m - £30m or so in cash. No assets. No production.

JKX - Mkt Cap £53m. 10, 500 boepd. £15m in cash. 2p reserves 58m

It makes no sense but I know which one I would put money in. Huge premium for Mr A's deal making abilities.

As the saying goes " it's better to travel than to arrive "

M Madar

12th Feb '21

serica looks very cheap -thanks for the idea

Joneseyboy

13th Feb '21

Thanks Jack. I’ve been holding JKX as a contrarian value play for 6 months. The road will continue to be bumpy but the rewards could be significant if there’s any form of mean reversion.
Any views on the oil giants against a backdrop of the world maybe, hopefully, opening up?

Norfolk'n'Good

17th Feb '21

Conclusion

I’ll circle back to Wentworth, Enwell, and DGOC later in the week but I’m curious to know: is anyone else looking at this part of the market, or is it just too risky?

Hi Jack

Will you be able to find the time later this week to finish the above? Particularly keen to hear your comments on £WEN

Many thanks

18th Feb '21

I'm nearly done with the second post. Unfortunately it was getting long so Wentworth didn't make the cut & I've focused on DGOC and ENW. There's plenty of ground to cover here so can always do a follow up post, but I also don't want to beat people over the head with O&G stocks so I might take a break from it after this one to focus on other areas of the market.

Fair enough Jack, I can see that you do put a huge amount of work and effort into these reports and as a relatively new investor I am always enlightened by their contents. They are so well researched and so informative.

I have had a position in Wentworth Resources (LON:WEN) for a few months, although as a Gas company it has a relatively unique position and market for its production and even a new investor can spot that its very cheap but I guess there's a good reason for that - I was hoping your report would help me understand more about the company.

In any event keep up the good work I know from the comments that I am not the only one that appreciates it!

Cheers

James

Oil & Gas watch - Serica Energy and JKX

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Jack Brumby

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