Rockhopper Exploration (LSE: RKH) has released an upbeat set of half-year results today. They provide guidance as to whether its shares have 20%-plus upside and if it’s a better buy than a more established resources peer such as Glencore (LSE: GLEN).
Rockhopper’s progress in developing the Sea Lion development remains strong. During the six months to 30 June, FEED contracts for the development were awarded to a set of highly regarded contractors. Alongside this, Rockhopper has benefitted from the lower-cost environment present in the oil and gas industry. This has reduced its costs and has also caused the break-even oil price required to sanction new projects to fall.
The successful exploration campaign that was run by Rockhopper means it continues to believe in the commercial viability of the North Falkland Basin. In fact, Rockhopper is of the view that there are a billion barrels of recoverable oil and that they can be produced in multiple phases of development over the medium-to-long term.
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Looking ahead, Rockhopper expects operating cash flow to broadly cover its overheads in future. It expects oil production for the remainder of 2016 to be around 1,500 boepd (barrels of oil equivalent per day) following its acquisition of Beach Egypt.
Is bigger better?
Rockhopper has considerable long-term potential and could turn around its 35% share price fall of the last year. However, it remains a relatively small company and with the outlook for the wider resources sector being highly uncertain, it could be a good idea to focus on a larger and more diversified peer such as Glencore.
Of course, Glencore is undergoing a period of intense challenges right now. Its debt levels were viewed as excessive by many investors and this caused its shares to come under severe pressure last year. However, the current strategy being employed by Glencore is allowing it to make rapid progress towards becoming less leveraged and more streamlined as a business. For example, it has made asset disposals, suspended dividends and reduced its cost base as it improves its overall business model.
Glencore is expected to return to profitability in the current year and then grow its bottom line by as much as 50% next year. This puts it on a price-to-earnings growth (PEG) ratio of just 0.6, which indicates that it offers 20%-plus upside.
Clearly, this is superior to Rockhopper’s valuation since Rockhopper is expected to remain lossmaking in each of the next two years. However, Rockhopper is an exploration company transitioning towards increasing production and so profitability is unlikely to be achieved for a number of years.
This doesn’t mean that Rockhopper should be avoided. It has 20%-plys upside given the strength and growth opportunities presented by its asset base. But with the outlook for commodity prices still uncertain, it may be prudent to stick to profitable, growing and cheap resources stocks such as Glencore. For these reasons, it is a better buy than Rockhopper at the present time since a 20%-plus return looks more likely and less risky.
