The oil sector has been one of the worst places in which to invest during the last year. That’s largely because the price of oil has collapsed to less than $50 per barrel and, looking ahead, many oil companies are planning for a future of low oil prices. This means that profitability is likely to be squeezed and investor sentiment could worsen, thereby hitting valuations across the sector even harder.
Furthermore, a low oil price has the potential to lead to asset writedowns, since the value of an oil-producing asset is undoubtedly lower if the price of oil is half what it was a year or two ago. A company that has suffered hugely in this respect is Premier Oil (LSE: PMO), which fell into loss-making territory last year, mainly due to a $327m impairment. Looking ahead, the company’s bottom line is due to remain in the red this year and, while profit is due to be delivered next year, further write downs would not be a major surprise and could lead to downgrades in future.
Of course, Premier Oil has posted a share price fall of 68% in the last year alone. Without a sustained rise in the price of oil, a return to its level from one year ago seems unlikely, but with the company’s shares now trading on a price to book value (P/B) ratio of 0.37, this indicates that its margin of safety is sufficiently wide to warrant investment for less risk-averse investors.
As well as a falling oil price, Genel (LSE: GENL) and Gulf Keystone (LSE: GKP) have had to endure prolonged cash flow challenges, with the Kurdistan Regional Government (KRG) failing to fully pay both companies for exported oil. Now, though, a payment programme appears to be in place and, while there is a degree of uncertainty regarding the reliability of future payments (especially if the political challenges in the region increase), the market appears to be cautiously optimistic regarding both companies’ financial futures.
In the case of Genel, it is forecast to post a rise in its earnings of 55% next year and, with the company’s shares trading on a price to earnings growth (PEG) ratio of just 0.4, it appears to have a sufficiently wide margin of safety to merit investment. And, while its shares are down by 58% over the last year, and appear to be unlikely to return to their level of November last year over the short to medium term, the quality of Genel’s asset base plus a rising oil price could push its valuation significantly higher.
Meanwhile, Gulf Keystone is forecast to remain a loss-making entity in the next two years and, while it has a high quality asset base and is operationally sound, its financial outlook is less appealing than many of its peers. So, while it could prove to be a strong performer in future years, and recover some of its 56% share price fall of the last year, a mix of a low oil price, a lack of profitability and a degree of uncertainty over future payments for oil exports mark it out as a stock to watch rather than buy at the present time.
