This strict set of criteria may seem a tall order, but there are bargains to be had and the one that I like most is Aim-traded Faroe Petroleum (FPM: 75.5p), an independent oil and gas company primarily focussed on exploration, appraisal and production opportunities in Norway and the UK. Importantly, the technical set-up is encouraging as having declined from a high of 152p last May, Faroe’s share price has found strong support at the 58p price level. Interestingly, this price point coincides with the share price lows in 2009 from which the shares almost quadrupled in value before hitting an all-time high of 221p four years ago. Having tested the 58p level in mid-December, the shares rallied before retesting it again in mid-January. The key for me was that there was clear positive divergence on the chart with the 14-day relative strength indicator (RSI) higher at the January retest than in December.
Moreover, a third attempt to retest those lows brought in buyers again and sent the shares rallying to the top of a 58p to 71.5p price range that has acted supported and capped progress since early December. In so doing the share price has regained the 50-day moving average, but is still massively below the long-term trend line, the 200-day exponential moving average, positioned at 94p. But with the 14-day RSI still only showing a reading in the mid-50s, so is in neutral territory, there is ample scope for the shares to continue their rally back towards their long-term trend line.
To add weight to this possibility, the moving average convergence divergence indicator (MACD) is not only above its signal line but is above zero too. The MACD is a trend-following momentum indicator that shows the relationship between two moving averages of prices and is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the signal line, is then plotted on top of the MACD, functioning as a trigger for buy and sell signals.
From a price perspective, the price move above the 71.5p top of the range on Thursday, 5 February is confirmation in my view that a base is in place and a tradable rally is on the cards back to the November highs around 94p. That price point neatly coincides with the 200-day EMA. So purely from a technical trading perspective, the shares are worth buying now. Importantly, the fundamental case for investing is supportive too.
Sound financials
In a pre-close trading update ahead of next month’s fiscal 2014 results, Faroe announced that it had net cash of £69.5m on its balance sheet after accounting for £23m of debt drawn down from a US$250m (£164m) banking facility. Net funds equate to a quarter of the company’s last reported net asset value of £290m.
It’s worth pointing out that Faroe’s gross cash balance of £92.5m covers this year’s exploration and appraisal capital expenditure of £95m, without tapping those debt facilities. Furthermore, the company benefits from the Norwegian fiscal regime which offers substantial tax incentives for exploration through the reimbursement of 78 per cent of costs in the subsequent tax year. This means the post-tax net cost of this exploration programme after the Norwegian rebate is expected to be only £25m this year. In addition, Faroe is planning development and production capital expenditure of around £16m. In other words, cash on the balance sheet easily covers this year’s capital spending plans.
It’s also worth noting that Faroe is a producer and guidance is for average 2015 daily production of between 8,000 to 10,000 barrels of oil equivalent (boe), split 58 per cent liquids (oil and condensate) and 42 per cent gas. Of this output, around 268,000 barrels of oil have been hedged at $90 each through put options and a further 825,000 boe of gas – equivalent to 52.6m therms – have hedging in place at 50p a therm. In total, this is over £40m of hedged revenue, or the equivalent to almost 30 per cent of fiscal 2014’s forecast turnover. It’s a profitable operation too as average expected operating expenditure is $30 per boe, significantly below the current spot price of Brent crude of $55 a barrel.
And those production forecasts are well underpinned following the acquisition last autumn of a 53 per cent carried interest in the Schooner Field and a 60 per cent operated interest in the Ketch Field in the UK Southern North Sea Basin from Tullow Oil (TLW: 402p). These assets are located 93 miles from The Theddlethorpe Gas Terminal on the Lincolnshire coast and have proved and probable reserves of 5.9m boe net to Faroe, consisting of 34 billion cubic feet of gas and 300,000 barrels of condensate. In 2014, the estimated average daily production from these interests was somewhere between 3,000 to 4,000 boe net to Faroe.
And with such a robust balance sheet, and funding lines in place, Faroe’s board are looking to take advantage of the company’s financial strength by making further value enhancing production acquisitions.
Exploration campaign
Faroe’s significant production aside, the company has an enviable track record of drilling success, something that it intends to build upon. This year the board plans to continue its low-cost, high impact exploration programme by drilling four wells including two follow up wells on its Pil oil discovery in the Norwegian Sea where Faore has a 25 per cent interest and VNG is the operator. In total, Faroe is targeting a total of between 93-490m boe gross unrisked Prospective Resources from these two wells, both of which will benefit from Norway's 78 per cent exploration tax rebate.
In addition, the Shango Field located in the Norwegian North Sea on the northern part of the prolific Utsira High, operated by oil major Total SA (TTA: €47.56) and where Faroe has a 20 per cent interest, is expected to spud in the first half of 2015. Shango has been derisked by the production performance of the nearby Skirne Field, so Faroe and its partners are banking on a spill over from Skirne into Shango. If successful, Shango will be targeted for fast track tie-back development across Skirne to the offshore Heidmal facility located 132 miles northwest of Stavanger, Norway. The drilling campaign here is targeting a large undrilled Jurassic structure with estimated unrisked gross Prospective Reserves of between 30m to 110m boe.
The fourth well will be drilled in the second half of 2015 on Faroe’s Blister prospect and targeting estimated unrisked Prospective Resources of between 20m to 90m boe. Faroe has a 7.5 per cent interest in Blister which is located within the Hyme/Snilehorn license adjacent to the Njord Field in the Norwegian Sea. Building on Snilehorn’s success since late 2013, and supported by evidence of a pressure barrier between Snilehorn and Hyme, this derisks the Blister prospect.
The bottom line is that this drilling campaign is in the price for free given that Faroe’s risked production is valued by analysts at brokerage Westhouse Securities at 70p a share alone. Add to that net cash on its balance sheet worth 27p a share and 36p a share of risked development assets and Faroe’s shares are trading on a 45 per cent discount to a sensible core risked valuation of 134p a share, not to mention almost a third below reported net asset value of 108p a share. That leaves a further 70p plus a share of risked valuation upside of which Westhouse attribute 58p a share to Pil (spilt between appraisal stage (32.6p), first follow up well (12.3p) and second follow up well (13.7p); 4.3p a share to Snilehorn; 3p a share to Shango; and 2p a share to Blister. There is a further 138p a share of unrisked valuation upside on these three fields which I have ignored.
In other words, with a total risked net asset valuation around three times the current share price, and net cash on Faroe’s balance sheet covering its capital expenditure programme, then any upside from the drilling campaign is in the price for free.
Trading strategy
So with the technical set-up favourable, and potential for positive newsflow from an active low-cost drilling campaign, the odds favour a continuation of Faroe’s share price recovery. Indeed, with the shares trading on a bid-offer spread of 75p to 75.5p, and a chart break-out above 71.5p confirmed, then an imminent sharp rally in the share price back to the November highs seems highly likely in my view. Needless to say, I rate Faroe’s shares a strong trading buy and have a short-term target price of 94p.
■ 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 £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
