Sound Oil (LSE: SOU) could be a terrific bet right now. What does it take to invest in it, though?
Here are a couple of scenarios you ought to consider before snapping up its shares.
19.25p A Share: Is It A Fair Price?
Its shares closed at 19.25p on Friday, some 7.25p below their 52-week high of 26.5p as of 28 April — a record that was hit when Sound Oil reported its 2014 preliminary results and announced the issuance of 63.1m new shares at a price of 19p a share.
The placing aimed to raise £12m, and also included “an equal number of detachable warrants to subscribe for new ordinary shares in the company at a price of 24p per ordinary share for a period of 5 years from issue”.
“Should all of the warrants be exercised, the average issue price of all equity issued in connection with the placing would be 21.5p”, the oil explorer added. Based on these elements, Sound Oil seems fairly priced at around 20p a share, particularly because not much has happened since. In fact, Sound Oil continued to trade in the mid-20s for about three weeks until 19 May on the back of a couple of minor trading updates, Morocco and Nervesa, which supported the investment case.
But soon after the stock started to fall, losing 36% in less than four weeks of trade as investors either overreacted to other trading updates or just took profit. On 16 June, Sound Oil closed at 15.3p; since then, the stock has surged 25%, and now it trades some 27% below its record high for the year.
Performance
Sound Oil has risen 75% this year, 87% over the last 12 months, and 102% in the past two years.
With 482.9m of shares outstanding, its market cap stands at £92m.
It announced last week that it had received “valid acceptances and excess applications from eligible shareholders for a total of 15,599,752 open offer shares“, which did little to boost its stock price, given that the statement referred to the last £2.8m tranche of the £12m placing.
So, the spotlight now is on any upcoming operational trading update. While it’s impossible to predict any such outcome, what’s known is that its latest unaudited financials showed revenues of £1m, which doubled year on year and imply a revenue multiple of 92x, which isn’t a very reliable valuation metric. Further down the income statement, 2014 losses per share have almost halved on the back of lower exploration costs that should rise over time, however.
Mixed signals come for the income and cash flow statements. Let’s look at the balance sheet.
Hunting For Value
Its unaudited cash balance of £12.6m as at 31 December 2014 amounts to a significant portion of its total assets, which stand at £38m — this is one element I like.
A back-of-the-envelope calculation suggests a realistic liquidation value of £30m, excluding the amount of cash it raised in its latest placing — I have assigned zero value to intangibles, which are worth £8m, but I have not applied any discount to ‘Property, plant and equipment’, whose book value stands at £13.2m.
Here is the conundrum: the stock trades in line with the price of the placing (19p), so it looks like investors are eager to bet on management and the business’s prospects, which indicate possible upside in the region of 30% or more (this is my best-case scenario); but given that its market cap trebles its liquidation value, downside could be as much as 66% (based on trailing unaudited financials), which should be adjusted, however, in order to reflect a lower level of risk than liquidation in the light of its funding needs over the next 18 months.