Gamble of the week: A beaten-up oil play

published 18 August 2014

If you own shares in a company, it goes without saying that you don't want to hear bad news. Shareholders in this oil company have had bucket loads of it recently. At the end of July, the company suspended its chief executive and chief operating officer it is investigating whether or not they have been paid money from an unauthorised source.

The situation deteriorated further last week, when the ongoing fighting in Kurdistan forced it to suspend operations at its key project in the country. It wasn't producing much oil, but was expected to make a big contribution in the years ahead.

To rub salt into the wound, credit-rating agency Standard & Poor's posted a negative outlook on the firm. It said the unauthorised-payments investigation might make banks reluctant to lend to Afren (LSE: AFR), which might hamper its ability to develop its big Nigerian oil projects.

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All this doom and gloom has wreaked havoc with the share price, which is down 40% this year. However, a quick glance at its share-price chart will tell you that investing in this company has been a roller-coaster ride for some time.

That's largely because investors are quite reasonably very wary of oil companies that make most of their money from Nigeria. It's become a very hostile place to do business.

Oil majors such as Royal Dutch Shell and Italy'sENI have been plagued by the theft of their oil and damage to their assets.The Nigerian government also seems intent on taking more money fromoil companies, meaning less moneyfor investors.

Projects in Nigeria andKurdistan, and exploration projects inKenya, Tanzania and the Seychelles,were set to boost oil production bymore than 10% a year for the next fiveyears.

Once the big investment spendingphase to develop the fields had peaked,investors could look forward to seeinglots of free cash flow pour in. Andanalysts are still predicting a big profitgrowth. According to Bloomberg, theyexpect trading profits to fall to $502mthis year, rising to $851m in 2016.

These forecasts should always be takenwith a big pinch of salt but what isundeniable is that Afren shares look verycheap. They trade at a 12% discountto their net asset value and offer anearnings yieldof nearly18%, based on this year's forecasttrading profits.

Some might argue thatthe risks here mean the shares shouldbe cheap. It's a fair point but the sharesmight bounce if Afren's problems abate.

Verdict: a risky buy

Phil spent 13 years as an investment analyst for both stockbroking and fund management companies.

After graduating with a MSc in International Banking, Economics & Finance from Liverpool Business School in 1996, Phil went to work for BWD Rensburg, a Liverpool based investment manager. In 2001, he joined ABN AMRO as a transport analyst. After a brief spell as a food retail analyst, he spent five years with ABN's very successful UK Smaller Companies team where he covered engineering, transport and support services stocks.

In 2007, Phil joined Halbis Capital Management as a European equities analyst. He began writing for MoneyWeek in 2010.