The shares of Renold (LSE: RNO) have lost about 10% of value this week. My advice? If you are invested, you may well decide to stay put. I do not hold the same feelings towards Gulf Keystone Petroleum (LSE: GKP) and IGAS Energy (LSE: IGAS), in spite of recent weakness in their valuations.
Consider that the combined equity value of these three companies amounts to just about £600m, but their combined valuation including net debt amounts to £1bn. Most of that £400m of aggregate net debt is owned by GKP, which is my least favourite pick.
IGAS’s balance sheet isn’t great, either — but Renold’s financial position is sound.
On A Roll
Renold has been under pressure this week on the back of a trading statement that confirmed guidance for its operating profit — quite simply, investors want more.
Of course, the drop in its share price could be a sporadic event, particularly if you believe that its management team has what it takes to deliver on its promises, but a scenario according to which the shares of Renold could sky-rocket to 150p in less than a year would imply a forward multiple of 30x, based on 2015 projections for its net earnings — such a valuation needs a higher growth rate than the one that Renold has delivered so far.
Its stock, currently valued at around 80p, traded at 27p only a couple of years ago. It has been flying high based on expectations that management will continue to deliver a nice mix of growth and yield over the medium term, and there are signs that value investors are right to have faith in the business — a supplier to the industrial sector, where valuations are not prohibitive, Renold is well managed and could also attract interest from suitors.
Following its rally — the shares are up 35% since the turn of the year– I’d not buy the stock until further updates, but I’d hold onto it if I were invested. Elsewhere, IGAS and Gulf Keystone Petroleum are more problematic, based on a series of risks.
Gauging Risk
The shares of IGAS and GKP are not cheap enough to deserve my attention, although I am more bullish on IGAS than on the oil explorer.
High debts are a problem that could bring lots of bearish comments regarding both companies, regardless of their operational performances — that’s called headline risk. At this stage of maturity, all sort of rumours could either sink or boost both companies’ stock prices in a flash.
Furthermore, both may need to raise more equity if their end markets do not improve quickly or their projects do not succeed — hence, dilution risk is something else you may have to consider before investing in them now.
Finally, regulatory risk could push back IGAS’s plans — IGAS strives to make an impact in the UK’s fracking industry, whose prospects are uncertain — while counterparty risk remains a serious threat to GKP’s viability. GKP has faced an uphill struggle to collect its credits this year.
IGAS stock is down 17% over the last month of trade, and currently trades at 25p. By comparison, the shares of GKP have fallen 16% to 33.6p since their one-month high on 26 June — lower oil prices are only partly to blame for its poor performance.
Frankly, there are cheaper options in the marketplace.
