What does Serica Energy do?

Serica Energy is one of Britain’s leading independent upstream oil and gas companies, with operations centred on the UK North Sea. It currently plays a leading role in the UK’s energy transition, with over 85% of its production being natural gas that has significant environmental advantages over other fossil fuels.

The UK shares continued their positive momentum after Serica Energy confirmed on Tuesday that it’s rejected an offer, by rival Kistos, that represented a 25% premium on their closing price. At the time of writing, the stock was trading at 348p, which is still 10% under the offer price. This indicates management has conviction that it can continue to deliver growth for investors. This is certainly a promising sign.

Oil and gas sector tailwinds to headwinds

The UK North Sea has been extremely lucrative for Serica. However, even with that being the case, there is no guarantee that future explorations will yield similar results. The company naturally also has a history of success, but if it does not strike proverbial gold in its ongoing exploration projects, such as the North Eigg project, it could be a considerable drain on its funds. This would naturally damage the share price and, importantly, could affect the company’s long-term plans and attractiveness.

The sector as a whole has received tailwinds this year thanks to runaway oil and gas prices. However, I do not see these prices as a long-term trend, and certainly not a sustainable one. In fact, I see this as more of a short-term symptom of the restructuring of global supply chains. I am not bullish on the long-term prospects and prices of oil, although the company is focused more intently on natural gas and this is certainly where the opportunity for Serica remains.

Conflicted: what I’m doing!

You would think that after such a meteoric rise — to the tune of 10,000% over the last decade — that the shares would look overpriced, but in a relative sense it still appears to hold pretty good value to me, trading at a price-to-earnings ratio of a little over 10. Since 2018 it has also multiplied revenue by a whopping 15x. Quite the feat for a company operating in such an uncertain sector.

All in all, despite the rosy picture painted and the demand for its assets at a premium by a rival company, I believe Serica could soon face turbulence in the shape of falling oil and gas prices. This means I expect the share price is at risk of becoming cheaper over the coming months to years.

Whilst I do still see value in Serica shares, I feel there are better long-term opportunities out there to park my cash today.

Oil and gas business

Serica is a leading mid-tier oil and gas business. In 2018, it completed an exciting acquisition of three fields in the North Sea from BP. This made it a substantial player in producing oil and gas in the lucrative North Sea.

So what’s happening with Serica shares? As I write, they’re trading for 312p. At this time last year, the stock was trading for 149p, which is a 109% increase over a 12-month period. Five years ago, the shares were trading for 26p, which means the shares have returned 1,100% based on current levels.

UK shares have risks

One of the biggest risks with commodity producers in my experience is the significant financial and operational issues they face when exploring assets. This is a costly exercise firstly, which could hurt Serica’s balance sheet as well as investor returns. Furthermore, if it is unable to yield any commodities from its exploration, the longer-term outlook for the business could also be affected.

Next, much has been made of the surging oil and gas prices in recent months. Although in the shorter term this could boost the coffers, the question that bugs me is whether this is sustainable longer term. The answer is usually no. I’ve often thought investing in commodities when commodities are volatile is a bad idea. I will keep an eye on developments here.

The bull case and what I’m doing now

Despite Serica’s remarkable share price rise in the past few years, the shares still look good value for money. They’re currently on a price-to-earnings ratio of 10.

So what has underpinned Serica’s rise in recent years? I believe its performance has definitely played a part. Although I am aware past performance is not a guarantee of the future, I review it to gauge the bigger picture. Looking back, I can see it has grown revenue year-on-year for three of the past four years. 2020 levels were affected by the pandemic. It is worth remembering many UK shares’ performance dipped during this unprecedented time. 2021 performance was excellent. I also note it has no debt and lots of cash. This is exciting as it could boost further investment, as well as payouts to investors.

Serica shares could boost my passive income stream through dividends. Its current dividend yield stands at 3%. This is in line with the FTSE 100 average of 3%-4%, despite being on the FTSE AIM index. I am aware dividends can be cancelled at any time, however.

Upon reviewing whether I would buy or avoid Serica shares for my holdings, I found myself torn. This is often a bad sign for me personally. The current negativity surrounding oil and gas prices is definitely a factor. Furthermore, the pitfalls of exploration for new assets in oil and gas businesses are well-documented.

I decided to stick to my general rule of not buying commodity stocks when prices and the market in general are volatile. I will keep a keen eye on Serica shares, however.

Since February 2017, this investment has turned £1,000 into more than £11,000, including dividends. That’s a potentially life-changing profit. Some investors think this share still looks cheap. I’ve owned this stock before but sold my shares too soon. Should I buy back in today?

Winning with oil and gas

The company in question is North Sea oil and gas producer Serica Energy (LSE: SQZ). Chief executive Mitch Flegg oversaw a transformational deal with BP in 2018, when the company bought the Bruce, Keith and Rhum (BKR) fields in the North Sea.

This acquisition made Serica a substantial North Sea producer. Over the last year, the group has been perfectly positioned to benefit from surging oil and gas prices. More than 85% of Serica’s production is gas, and the company supplies around 5% of total UK gas production.

Broker forecasts suggest that Serica will report a profit of around £200m for 2021, compared to £64m in 2019 and just £8m in 2020.

I’ve been a fan of Serica for a while. In my view, this is a well-run business with strong finances. I certainly regret selling my shares in October last year — the stock has risen by another 20% since then.

Is this former penny stock still cheap?

I think Serica shares could still be cheap. But there are a couple of things about the company’s valuation that make me cautious.

First of all, the shares are currently trading on a price/earnings (P/E) ratio of just three times 2022 forecast earnings. That’s unusually low, even for a fossil fuel stock. BP, for example, has a forecast P/E of seven.

My second concern is that Serica’s dividend is unusually mean. The group’s net cash balance was £218m at the end of 2021. Earnings of 82p per share are expected for the year — a record high. Despite this, broker forecasts suggest the 2021 dividend will be just 3.5p per share, giving a measly 1.6% dividend yield.

These numbers suggest to me that the market doesn’t believe Serica’s profits are sustainable. I share this view. At some point, I think that lower oil and gas prices plus rising decommissioning costs will cause Serica’s profits to plummet.

I also get the feeling that Mr Flegg is holding on to the company’s cash because he expects to need it in the future. My guess is that Serica’s big cash pile is being earmarked for decommissioning costs and — perhaps — for acquisitions to replace the BKR fields, when they start to decline.

Serica share price: my decision

I think Serica is a good business and I admire what chairman Tony Craven-Walker and CEO Mitch Flegg have achieved. It’s possible that the two men will continue to expand this business, rewarding shareholders.

However, I just don’t think the shares are as cheap as they might seem.

In my experience, buying commodity producers when commodity prices are high is often a bad idea. Although I think Serica’s profits may rise this year, I suspect they will fall from 2023 onwards. On balance, I think it’s probably too late for me to buy.

Novacyt

First up is former penny stock Novacyt (LSE: NCYT). Based on analyst projections, shares in the clinical diagnostics specialist trade on just five times earnings. That seems ludicrously cheap considering this month’s half-year numbers.

Total revenue jumped 50% to £94.7m in the first six months of 2021 compared to the same period last year. A little under £54m of this came from overseas orders and the private UK testing market. The latter includes buyers operating in, for example, the film and travel industries.

Looking ahead, Novacyt thinks there could be more growth ahead thanks to fresh contracts, a new PROmate Covid-19 test launch, travel routes reopening and the colder weather arriving. While this all sounds great, there’s a chance that the last two of these won’t happen as quickly as the company would like. An ongoing dispute with the Department of Health and Social Care isn’t ideal either. 

Taking into account how volatile the shares have been over the last year, Novacyt is still only a cautious buy for me.

Serica Energy

Another ‘cheap’ AIM stock is Serica Energy (LSE: SQZ). The North Sea-focused oil and gas company’s shares trade on just five times earnings. That might prove a bargain in time.  In July, SQZ announced promising flow test results from its 50%-owned Columbus development well. The stabilised rate was “at the upper end” of what Serica expected. Once up and running, it’s believed the well will produce roughly 7,000 boe/d (barrel of oil equivalent per day).     As someone with only mixed success in this sector, I’m hesitant to buy shares in Serica. That said, I like that the company began 2021 with no debt and £90m in cash. The fact that the AIM stock is already producing from its Bruce, Keith and Rhum fields (previously owned by BP) is another positive. 

However, the risks involved in future drilling campaigns (such as the North Eigg project), not to mention the opportunities available elsewhere, can’t be overlooked. So, Serica would be another cautious buy for me.

Atalaya Mining

For an even lower valuation, I’d check out Atalaya Mining (LSE: ATYM). It’s trading at just four times forecast earnings. 

Atalaya produces copper concentrates and silver by-product at its 100% Proyecto Riotinto site in Spain. It also has an agreement to own up to 80% of Proyecto Touro, a brownfield copper project in the same country. And, based on recent numbers, this is another AIM stock that could prove to be a steal.

Benefiting from a strong copper price, EBITDA rose to just under €100m in the first half of 2021. Like Serica, Atalya also has a strong balance sheet with net cash of €37.8m at the end of June.

Of course, risks abound. Aside from setbacks that plague exploration, ATYM is never in complete control of its fate. Long-term demand for copper looks robust but commodity prices can be very hard to predict in the near term. That’s fine if I’m being paid to wait. However, there’s no dividend stream with Atalaya.

It goes on my watchlist for now. 

Although the coronavirus pandemic has put a big dent in oil demand, I expect demand to improve during the second half of 2020. I’ve identified three UK oil stocks which I think should perform well in this scenario.

A long-term winner?

If you’re looking for oil stocks to buy, you can’t ignore the FTSE 100‘s biggest company, Royal Dutch Shell (LSE: RDSB).

Shell hit the headlines last week by cutting its dividend for the first time in 75 years. This will reduce the stock’s dividend yield to around 3.8%. Although this is a disappointment for income investors, I think it’s a far-sighted decision that will prove to be correct.

At more normal oil prices, Shell is a formidable cash machine. Its oil business has low operating costs for fields that are already in production. The group also has a very large gas business and a sizeable ‘downstream’ division – that’s industry jargon for refineries which convert oil into petrol, diesel, and chemicals.

I see Shell as a potential winner as the coronavirus pandemic recedes. I’m also encouraged by the company’s plans to cut emissions over the coming years. I remain a buyer.

One North Sea oil stock I’d buy

North Sea firm Serica Energy (LSE: SQZ) has been around for 15 years. But in 2017 the firm acquired a number of oil and gas fields from BP. This deal transformed the company into a mid-tier producer with 2019 production of more than 30,000 barrels of oil equivalent (boe) per day.

More than 80% of Serica’s production is gas, which is piped to the UK for electricity generation. Operating costs are low, too, at just $12.60 per boe.

Serica’s low costs support strong cash generation, and net cash rose from £43m to £102m in 2019. The group plans to pay its first ever dividend in July, giving the stock a forecast yield of more than 3%.

Serica could still face challenges from coronavirus. In the future it could face significant decommissioning expenses. But the shares look reasonably priced to me. I’d be happy to buy at current levels.

I think this oil stock could double

The final company on my list produces oil for an operating cost of just $3 per barrel. Genel Energy (LSE: GENL) was one of the first companies to strike oil in the Kurdistan region of Iraq. It remains a leading producer in this region.

There are some potential problems for investors. Genel’s oil is sold to the Kurdistan government and payment is sometimes delayed. The political environment isn’t always stable. However, this business has a track record of operating successfully and maintaining a good relationship with the authorities. I can live with the political risks.

Genel’s net cash stood at more than $90m at the end of last year, supporting a generous dividend. Looking ahead, analysts currently expect the firm’s strong cash generation to support a 9% dividend yield in 2020.

This oil stock isn’t without risk, but if oil prices rise stabilise above $40, I think shareholders could see big gains. I’d be happy to take a small position in Genel.

There’s still no news of a deal to provide the $3.5bn needed to fund the remaining build of the mine. The company has already warned that it could run short of cash by the end of June.

Management has previously said it hopes to announce a deal by the end of April. I suspect the funds will be found, but I fear that the cost to shareholders will be higher than expected.

Not so cheap

As I’ve pointed out previously, Sirius is already valued at nearly $5bn, if you include the money it needs to raise.

That’s roughly half the firm’s forecast net present value of $9.8bn. This represents the value in today’s money of the cash Sirius will generate over the mine’s life, based on mid-range predictions about fertiliser prices and production volumes.

In my view, a share price of 20p is about right at the moment. History suggests major projects like this usually cost much more than expected. As my colleague Rupert Hargreaves explained recently, Sirius has already increased its cost estimates several times.

I’m going to continue to avoid Sirius Minerals until funding is agreed. I’m more interested in the opportunities for value creation at this fast-growing oil and gas firm.

The shares are up by 1,200%

Shares in North Sea oil producer Serica Energy (LSE: SQZ) have risen by more than 1,200% over the last five years.

The firm went into the 2015 oil downturn with net cash and a production asset. In 2017, management used these advantages and its North Sea presence to agree a deal with BP to buy its share of the Bruce, Keith and Rhum fields, collectively known as BKR.

Serica has published its 2018 results today, giving investors their first chance to see how this deal is working out. The signs are promising. Although Serica didn’t become the operator of the fields until 30 November, my sums suggest that the resulting cash flow lifted Serica’s underlying operating profit from $14.1m in 2017 to $20.8m.

The accounting for this deal is a bit complex. But in my view, broker forecasts for 2019 revenue of $414m and a net profit of about $162m look reasonable. That means the shares currently trade on a forecast price/earnings ratio of less than 3, even after today’s gains.

What could go wrong?

It seems that the market is still a little sceptical about the long-term success of the BKR deal. So what could go wrong?

One risk is that Serica’s management will now use the firm’s cash flow to start empire-building, making too many expensive acquisitions.

Another risk is that the Rhum field is 50%-owned by the Iranian Oil Company. Due to US sanctions, production requires a US government licence, renewed annually. So there’s an ongoing risk of disruption.

Finally, it’s possible that the performance of the BKR fields will fall short of expectations over the next few years. So far there’s no reason to expect this, but I’m not an expert on these assets.

My verdict: I believe Serica Energy could continue to generate value for shareholders. To lessen the risks, I’d aim to buy on the dips from now on. I’d hold.

What’s interesting is that BP shares are now within about 15% of their all-time high of around 700p. Today I’m going to ask whether this FTSE heavyweight could print a new all-time high in 2019.

I’m also going to look at a small-cap oil firm whose share price could double over the next 12 months.

Ignore the forecasts

Over the last 12 months, consensus forecasts for BP’s 2018 earnings have risen by 50% to $0.56 per share.

Historical data provided by Reuters shows that BP’s earnings have beaten quarterly forecasts consistently since mid-2017. Rising oil prices have added fuel to the fire.

Analysts have simply been playing catch-up.

Let the facts speak

The good news is that there are some hard facts we can use. Between 2010 and 2013, BP generated an underlying replacement cost profit — the most comparable measure — of between $13.4bn and $21.2bn each year.

In 2017, underlying replacement cost profit was just $6.2bn, less than half the minimum underlying profit earned during the last oil boom.

Why I’m bullish

The price of oil is still lower than it was in 2010-2013. But BP’s costs are also lower and the firm is now focused on maximising profits rather than just pursuing growth.

At the time of writing, the shares were trading on 14 times 2018 forecast earnings, with a 5.1% dividend yield.

My sums suggest that the group’s profits and dividend would only need to rise by another 15% to justify a share price of 700p.

Commodity producers always carry some risk. But with production and oil prices still rising, I think there’s a good chance that the BP share price will set new records some time soon.

A potential double bagger?

Small-cap Serica Energy (LSE: SQZ) is poised to become one of the beneficiaries of BP’s decision to exit older North Sea assets. The company expects to complete a deal to buy stakes in the Bruce, Keith and Rhum (BKR) fields from BP and French firm Total at the start of November.

Serica will then be entitled to a share of net cash flows from the fields from 1 January to the completion date.

These two deals are expected to increase the group’s proven and probable reserves from 3m barrels of oil equivalent (mmboe) to 60mmboe. Impressively, this has been done without raising debt or issuing new shares.

The firm reported a loss for the first half of 2018 today, as production from its Erskine field has been suspended due to a pipeline fault. However, this is one case where analysts’ painstaking calculations can be useful.

Forecasts for the full year — including cash flow from BKR — suggest Serica could generate earnings of $0.41 per share in 2018, if the deal completes as expected.

These projects put the stock on a forecast P/E of just 2.8, falling to a P/E of 2.2 in 2019.

Such a low valuation multiple is unlikely to be sustainable. If the BKR deal delivers as expected, I believe Serica’s share price could quickly double from current levels, to reflect the expanded firm’s profits and cash generation.

That’s why I rate this stock as a speculative buy.

Big acquisition

The big news in November was that the company announced the acquisition of BP’s interests in the Bruce, Keith and Rhum fields in a move set to diversify Serica’s revenue and reduce its dependence on the Erskine field. Benefits of the deal will be higher production volumes and reserves, and the ability of the firm to use its prior tax losses to offset profits. The directors say the deal is “structured to control risk and minimise shareholder dilution,” and they expect it to complete during the third quarter of 2018.

The firm’s improved prospects drove the shares up during the year. In November, you could have picked up some of the stock at 27p, but today the shares change hands for around 67p. Yet they’ve been higher, touching 91p or so in January. Chief executive Mitch Flegg said that the firm is working hard towards the transition of the assets from BP as well as looking for new assets to add in the UK North Sea to grow the business, “where there are strategic benefits for Serica.”

City analysts following the firm expect earnings to increase around 512% during 2018 and 27% the year after that, which throws up a tempting forward price-to-earnings ratio of just over two, although the future financing outcomes resulting from the deal with BP makes the valuation a little muddy for the time being. Nevertheless, I think Serica is an interesting investment proposition that could sit well in a portfolio alongside oil major Royal Dutch Shell (LSE: RDSB).

Big dividend

One of the striking things about Shell is its forward dividend yield running close to 5.7% for 2019. City analysts expect earnings to rise 53% this year and 9% in 2019. Those earnings should cover the dividend payment around 1.4 times, which is quite a low level of cover from earnings, suggesting the directors may see little opportunity to invest in further growth projects.

Back in February with the full-year results report, chief executive Ben van Beurden said 2017 was a year of “transformation,” just like it was for Serica. Driven this time, though, by a “relentless focus on value, performance and competitiveness,” which saw the firm generate $39bn of cash flow from operations, excluding working capital movements, from an “upgraded” portfolio.

As an income stock, Shell looks tempting, but a glance at the share-price chart reveals how volatile the stock can be because of its cyclicality. Commodity prices have been firmer lately, but that situation can reverse, and if the share price declines, the capital you lose could wipe out years of income gains from the dividend. That’s one reason I think it could be worth diversifying your holdings in the sector to include potential growers such as Serica Energy.

Profit from market caution

Small-cap North Sea oil producer Serica Energy (LSE: SQZ) has risen by 200% since last September. This surge followed the news that the company had agreed to use some of its cash pile to buy three mature, producing North Sea oil fields from supermajor BP.

The Bruce, Keith and Rhum (BKR) fields will add 50m barrels of oil equivalent to Serica’s reserves. They’re expected to increase the group’s net production to 21,000 barrels per day. The resulting cash flow is expected to lift the group’s profits from $10.8m in 2017 to $83.4m in 2018.

However, the share price doesn’t yet reflect these gains. Serica stock currently trades on a 2018 forecast P/E of 3. It’s clear that investors aren’t yet willing to credit the firm’s transformation.

Two risks

The first risk facing Serica is that production from its only producing field is currently stopped due to a pipeline blockage.

Output from the Erskine field was cut off in January, during cleaning operations. According to an update today, a small gap has been opened up, but service has not yet resumed. In the meantime, the group must be losing money.

A second risk is that the BP transaction isn’t expected to complete until the third quarter of 2018. Although the deal will be backdated to 1 January, the company won’t receive any cash from the BKR fields until late this year.

I don’t see either of these risks as a major concern. Serica reported net cash of $30.7m at the mid-point of last year and should be able to ride out any short-term losses. I believe the shares could double again over the next 18 months.

More of the same, please

Yesterday’s final results from mid-cap oil and gas firm Premier Oil (LSE: PMO) received a fairly positive reception from the market. The group’s stock — which I own — has tripled from the lows seen in January 2016, but continues to offer good value in my view.

I’ve recently bought more of these shares because I don’t think the 71p price reflects all of the progress that’s likely over the next 18 months.

The first area of improvement is debt reduction. Yesterday’s results showed a marginal fall in net debt to $2,724.2m in 2017. But the firm also released details of bond redemptions which lead me to think that this net debt figure could already be around $200m lower, at about $2.5bn.

Debt reduction is expected to speed up in the second half of this year, as production from the Catcher field reaches full capacity. In the meantime, I think some of the company’s undeveloped assets could attract outside interest.

Funding has already been agreed to develop the Tolmount gas field, which is targeting 540 billion cubic feet of gas resources. But Premier also has last year’s “world class” Zama oil discovery in offshore Mexico and the Sea Lion field in the Falkland Islands.

The stock currently trades on a 2018 forecast P/E of 6, reflecting its high debt burden. But as borrowings fall and progress is made with new projects, I expect the shares to rise significantly from current levels.

I reckon I’m seeing that with BooHoo.Com (LSE: BOO), just as surely as I saw it with ASOS before. In the latter case I was sure the early share price rise was too much, too soon — I said it at the time and I’ve been proved right, as the shares crashed and have still not regained their early overblown peak.

Looking at Boohoo I see impressive rising profits for sure, and I certainly like the look of that. And forecasts for EPS growth of 38% in the year to February 2018 followed by a further 24% the year after look very tempting. But I must note that we’re already seeing a slowing in early growth, after last year brought a 97% rise and the year before racked up 48%.

Too expensive

Now, those are still great forecasts, but to put them into a valuation context, let’s look at PEG ratios. The PEG compares the prospective P/E ratio with the expected EPS growth to try to see if the current share valuation is justified by growth expectations. A value of 0.7 or less is often seen as a great indicator, while anything under around one is still pretty good.

Forecasts for Boohoo suggest a PEG greater than two for next year, rising to nearly three a year later. And P/E multiples come in at 84 and 69 for the two years respectively — the FTSE 100 average is around 14.

If the shares aren’t significantly cheaper than today’s 195p sometime in the medium-term future, I’ll be ready to ingest some headwear.

Better growth prospect

I’m more impressed by the growth prospects for oil and gas explorer Serica Energy (LSE: SQZ).

Having faced the oil price crisis and come out of it with the price of a barrel hovering around $50, I see the crushing pressure of super-low prices that critically endangered a number of indebted and unprofitable companies as receding, and I reckon we’re emerging into a new period of optimism for explorers.

Serica is profitable and has been for a couple of years, and we’re seeing forecasts that would double earnings per share this year to produce a very low P/E of only a little over four. Of course, the erratic nature of oil exploration profits means we shouldn’t treat this measure in the same way we would for most other sectors, but Thursday’s interim results do leave me feeling a little on the bullish side.

Growing profit

The company reported a post-tax profit of $10.3m, compared to a loss this time last year of $2.8m, and I was impressed by an operating cost (including transportation and processing) of $14 per barrel of oil equivalent. That’s low, and it suggests Serica has a reasonable safety margin should we enter a new phase of volatile oil prices.

Investors have been a little cautious of late due to an operations delay at the firm’s Erskine platform, but an update this week told us that production has successfully recommenced.

The Erskine field averaged 3,100 barrels per day up until May, and 2,800 barrels over the full period. And now it’s back online, I don’t see any great fears.

Serica’s period-end cash of $30m with no debt makes me see it as relatively low risk for the sector.