Firstly, production is uneconomic for many operators with benchmark West Texas Intermediate (WTI) and Brent Crude hitting lows sub $50 a barrel at the end of January, so supply would adjust in time and lead to a tighter market. Secondly, I took the view that the decline in the price was out of sync with the global economic growth forecasts for this year and next, so if supply readjusted downwards then it wouldn’t take much to send the oil price rallying if demand proved more robust than many had envisaged. We are already seeing this scenario pan out as the number of rigs operating in fields in the US has hit a six month low as shale gas operators adjust to lower prices, and both WTI and Brent Crude benchmarks have rallied by over a third from their winter lows.
The oil price momentum is unlikely to stop here either as the 1.5m barrel a day surplus in the global market which depressed oil prices earlier this year is only marginally above the 1.2m barrel a day growth in global demand forecast by OPEC in 2015. A market in surplus could easily become a tight market if global economic conditions confound the sceptics as I believe will be the case. I am not the only one thinking this way as hedge funds are betting on a continuation of the oil price rally. In fact, one notable Swiss based fund is predicting Brent Crude will hit $82 a barrel by the start of next year.
A favourable backdrop
The oil price rally is proving a decent backdrop for my favoured exploration and production, Aim-traded Faroe Petroleum (FPM: 86p), an independent oil and gas company primarily focused on opportunities in Norway and the North Sea. I initiated coverage when the price was 75.5p ('A slick operator', 6 Feb 2015), reiterated the advice at 79.5p ('Buyouts and bumper profits', 25 Mar 2015) and last updated the investment case at 86p (‘Flying high’, 14 April 2015).
An operational update from the company this week gives me every confidence that a return to the 100p price level and my upgraded target price could be on the cards in the coming months.
Indeed, the company has reported record production of 11,324 barrels of oil per day (boepd) in the first five months of the financial year, up from average economic output of 7,582 boepd in the first half of 2014. It’s also well ahead of guidance of 8,000 to 10,000 boepd for 2015 as a whole. Reflecting increased throughput and lower production costs, average operating cost was only $22 per barrel in the latest five month trading period, significantly less than guidance of $30 a barrel for the full year. It’s worth noting too that 58 per cent of Faroe’s current fiscal year post-tax production is hedged out at $89 a barrel and 50p a therm for gas.
So given the current spot UK wholesale price is 42.6p a therm for gas and $64 a barrel for Brent crude, I reckon Faroe’s exploration budget (£26m post-tax for 2015), and development budget (£17m in 2015), could be cash neutral this year as bumper cashflow from production is recycled back into what has been a highly successful exploration programme. In fact, the company has just reported that its net cash position improved by 20 per cent to £84m since the start of 2015. In my opinion, this week’s operational update set the company up for a decent set of interim results in late summer.
Drilling campaign stepping up
There should be other potential catalysts to underpin share price gains, too. Drilling has now started on the first of two follow-up wells at the significant Pil discovery (Faroe has a 25 per cent interest) on the Blink and Boomerang prospects in the Norwegian North Sea, located 30 km to the southwest of the producing Njord filed in which Faroe has a 7.5 per cent interest. The Boomerang exploration well is located in water depth of 320 metres and is operated by VNG Norge AS (30 per cent interest) using the Transocean Arctic semi-submersible drilling rig with partners Spike Exploration Holdings AS (30 per cent interest) and Rocksource Exploration Norway AS (15 per cent). The drilling programme will target prospective resources in the Upper Jurassic reservoirs analogous to the Pil, Bue and Draugen field reservoirs.
We can also expect news on the Shell operated exploration well to test the Portrush prospect in the Norwegian Sea located only 10km from the Nojord field and in which Faroe has a 20 per cent interest. The exploration well will target prospective resources along the Vingleia fault in analogous Upper Jurassic reservoirs to Pil, Bue and Draugen. The well will benefit from reduced rig rates and the timing of the campaign will allow the results from a discovery to be included in forthcoming concept selection and development decisions in the greater Njord and Draugen areas.
It’s worth noting that the ongoing drilling campaign, which benefits from lucrative tax breaks from the Norwegian government, is in effect in the price for free. That's because Faroe's risked production is valued by analysts at 70p a share and the company currently has net cash on its balance sheet worth 32p a share. Combined this is worth just over 100p a share, or my initial target price on the shares. As a result we have a completely free carry on Faroe's risked development assets (valued by analysts at 36p a share), and all its unrisked assets, so any positive news on the drilling front is likely to be well received.
Interestingly, from a technical perspective, a share price close above 91p – a level which capped progress in early April - would be very bullish indeed as it would produce both a point and figure and swing buy signal on the charts. It would also be a strong signal that a run up to my 100p target price is underway.
Offering 16 per cent upside to my target price of 100p, I continue to rate Faroe shares a buy on a bid-offer spread of 85.75p to 86p.
Greenko board in key discussions
It would appear that the board of Greenko (GKO: 55p), the Indian developer, owner and operator of clean energy projects, have been listening to their shareholders. They have now entered into discussions with two major investors to work out a compromise deal to prevent a highly dilutive share issue on the conversion (into ordinary shares) of the minority interests in Greenko Mauritius held by the Government of Singapore (GIC) (whose investment has a value of £140m), and Global Environment Emerging Markets (investment has a value of £75m).
This is clearly good news as both GIC and Global Environment Emerging Markets (GEF) have the right to convert their investments (GIC owns 17.38 per cent of Greenko Mauritius and GEF owns 14.09 per cent) into Greenko’s ordinary shares from the start of July, so this issue needs resolving as soon as possible. I discussed this important point when I last updated my view when the price was bombed out at 44p (‘Catalysts for share price moves’, 4 Jun 2015). The latest news initially sparked a 50 per cent plus rally in Greenko’s share price to a high of 68p yesterday morning, albeit it only returned the price back to the 70p price level they were trading at seven weeks ago (‘Break-out looms for mobile wonder’, 12 May 2015) before some profit taking set in yesterday afternoon.
My advice is to hold firm and await news on details of the compromise deal the company is trying to work out with these two major investors as there could be more significant share price upside in the event of an amicable resolution. That's because after factoring in a December 2015 year-end net debt figure of around $920m (£590m), an increased issued share capital of 329m shares - assuming that GEF and GIC accept conversion terms around 100p a share as I discussed in my article in May - then Greenko's enterprise value of $1.5bn (based on a share price of 100p) would still be only 8.5 times fiscal 2016 operating profit estimates and 7 times likely cash profits.
Of course a conversion price of 100p a share is well above Greenko’s current share price, but still represents a chunky discount on the 180p level the shares were priced at last summer, and more importantly the share price at the time when they made their investments in the first place. Moreover, there is no point at all for the two major shareholders to undermine the ability of Greenko's board to progress with its expansion plans as GIC and GEF are still only minority shareholders in Greenko Mauritius, owning less than a third of that subsidiary between them. Hold.
Communisis unloved
Shares in Communisis (CMS: 48p), a marketing services company, have fallen back to a six month low of 48p in the three months since my last update post the final results in early March when the price was 56p ('Six-shooter of small-cap buys', 10 Mar 2015). Since then the company has reported an encouraging start to the financial year at its annual meeting in early May. Underlying trading was inline with current market forecasts for all three of its divisions in the first quarter, and integration of recent acquisitions is progressing to plan.
One of these business units provides brand deployment services support through management of third party supply chains for the sourcing and distribution of in-store marketing. In recent years this business has expanded rapidly and successfully overseas which has helped Communisis’ international revenues grow by 36 per cent to £66.5m in 2014 to account for 19.4 per cent of group turnover of £343m. The client base encompasses a growing number of global leading brands in the consumer goods sectors including Proctor & Gamble.
Although the brand deployment business is trading in line with management’s guidance, the weakness of the Euro against sterling is an issue as half of divisional revenues of £55m last year were denominated in Euros. Analysts at broking house N+1 Singer believe that the 10 per cent depreciation of the Euro since Communisis’ budgets were set will prove a drag on divisional profits and lead to a 4 to 5 per cent profit at the group level.
But this currency related downgrade needs to be put into perspective as based on a rise in group revenues to £370m in 2015, reflecting a raft of higher margin contract wins and the contribution from acquisitions, N+1 Singer would still expect Communisis to report a 26 per cent rise in pre-tax profits to £17.3m and lift adjusted EPS by 40 per cent to 6.65p. So with the shares priced at only 48p, the forward PE ratio is just 7, or less than half the support services sector average. Moreover, the board are still expected to lift the payout by 10 per cent to 2.2p a share, so the prospective dividend yield is pretty attractive at 4.6 per cent too. They are also priced on a 14 per cent discount to book value of 56p.
Communisis’ shares may be unloved, and are well adrift of the 69p level at which I reinitiated coverage 16 months ago (‘Making the right communications’, 3 Feb 2015), but I still see value here. Ahead of the interim results scheduled for release on Thursday, 30 July 2015, I rate the shares a medium-term buy at 48p.
MORE FROM SIMON THOMPSON...
At the end of April, I published an article with all of the share recommendations I have made this year. Since then I have published articles on the following companies:
■ Marwyn Value Investors: Buy at 220p, target price 260p ('Exploiting a value play', 5 May 2015)
■ Pure Wafer: Buy at 113p, target 140p to 150p; Paragon: Run profits at 440p, but buy on a confirmed breakout above the 445p and new target of 500p; 600 Group: Buy at 16.5p, target 24p; Fairpoint: Buy at 127p, target 190p; AB Dynamics: Buy at 207p, target 230p ('Repeat buy signals', 11 May 2015)
■ Globo: Buy at 56p, target 69.5p; Greenko: Hold at 70p; Pittards: Buy at 128p ('Breakout looms for mobile wonder', 12 May 2015)
■ Macau Property Opportunities: Buy at 214p; Dragon-Ukrainian Properties & Development: Hold at 28p; Raven Russia: Hold at 53p ('Overseas property plays', 13 May 2015)
■ Trakm8: Run profits at 135p; Redde: Buy at 120.75p, target 140p; STM: Run profits at 45p, but conditional buy on close of 48p and new target of 60p ('Smashing target prices', 14 May 2015)
■ Bilby: Buy at 75p, target 100p ('Buy to build' growth play, 18 May 2015)
■ Bioquell: Buy at 148p, target 170p to 185p; Somero Enterprises: Buy at 140p, target 185p; KBC Advanced Technologies: Buy at 109.5p, target 165p; Inspired Capital: Hold at 14.25p ('Three value plays', 19 May 2015)
■ Renew Holdings: Buy at 315p, target range 350p to 375p; Manx Telecom: Buy at 198p, target 210p ('Renewing old acquaintances', 20 May 2015)
■ Marwyn Value Investors: Buy at 228p, target 260p; Charlemagne Capital: Hold at 13.5p; Bloomsbury Publishing: Hold at 178p ('Lights, camera, action', 21 May 2015)
■ Anite: Buy at 91.5p, target 110p ('Testing a breakout', 26 May 2015)
■ Character Group: Buy at 415p, target 525p ('Playtime', 1 Jun 2015)
■ Tristel: Run profits at 96p; Pure Wafer: Buy at 123p, target range 140p to 150p; Crystal Amber: Buy at 153p ('Hitting target prices', 2 Jun 2015)
■ B.P. Marsh &Partners: Buy at 150p, target range 170p to 180p; Moss Bros: Buy at 110p, target range 120p to 130p; SeaEnergy: Sell at 15p ('Exploiting a valuation anomaly', 3 Jun 2015)
■ Globo: Buy at 59p, target 69.5p; London & Associated Properties: Buy at 38.5p; Greenko: Hold at 44p ('Catalysts for share price moves', 4 Jun 2015)
■ Burford Capital: Buy at 148p, target 190p ('Legal eagles', 8 Jun 2015)
■ Market strategy ('Financial Market Watch', 9 June 2015)
■ Software Radio Technology: Buy at 29.5p, target 40p to 43p; Tristel: Run profits at 92p; Creston: Buy at 136p, target 150p; Sanderson: Buy at 69p, target range 80p to 85p ('Blue sky potential', 10 June 2015)
■ 1pm: Buy at 67p, target 80p; Vislink: Buy at 58p, target 70p ('Small-cap growth stocks', 11 June 2015)
■ Elegant Hotels: Buy at 105p, target 135p to 140p ('Checking into an elegant investment', 15 June 2015)
■ First Property: Run profits at 45p; AB Dynamics: Run profits at 225p and target 250p; Inspired Capital: Sit tight at 20p (Bargain shares updates', 16 June 2015)
■ Trakm8: Run profits at 159p, new target 180p; Anite: Sit tight at 126.75p; Trifast: Run profits at 129p, target 140p; Record: Buy at 37p ('Small cap wonders', 17 June 2015)
■ Inland: Run profits at 71p, target 80p; KBC Advanced Technologies: Buy at 110p, target 165p; Caretech: Buy at 237p, target 300p ('Riding an earnings upgrade cycle', 18 June 2015)
■ Ensor: Buy at 97p, minimum target 125p ('Building up for a takeover', 22 June 2015)
■ GLI Finance: Buy at 54p, target 80p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('A tripple play of small cap picks', 23 June 2015)
■ Bilby: Run profits at 97p; Safestyle: Run profits at 220p; Epwin: Run profits at 134p (‘Soaring small caps’, 24 June 2015)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
