These recovery stocks are flying. Should I buy?

These shares are taking off and it looks as if there’s still plenty of time to buy, says Rupert Hargreaves.

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I think it’s fair to say that this time three years ago, shares in Gulf Keystone Petroleum (LSE: GKP) and Genel Energy (LSE: GENL) were on the rocks. 

However, fast-forward to today and the situation couldn’t be more different. Both companies have weathered the storm and are now starting to emerge from the cloud of uncertainty that has shadowed them for the past few years.

Profits rising

Gulf Keystone’s turnaround is particularly impressive. At the end of 2016, it looked as if it was heading for bankruptcy and only a colossal debt restructuring helped save the business, although it almost completely wiped out shareholders.

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Now, after several years of hard work, the company has not only completely recovered, but it looks to be one of the most well-funded and profitable oil businesses trading in London today.

According to its full-year 2018 results, Gulf Keystone ended 2018 with a net cash balance of $191m, up $135m year-on-year. Profit from operations hit $78m and earnings per share came in at 26p. On this basis, shares in the company are trading at a P/E of around 10, that’s without adjusting for cash which currently makes up around 17% of the group’s £580m market capitalisation.

Management also declared a $25m dividend alongside Gulf Keystone’s 2018 results, which gives a yield of around 3.3% on the market-cap, according to my calculations. That’s quite an attractive return for a company that was facing bankruptcy only a few years ago.

Further to go

And I think this could be just the start of Gulf Keystone’s comeback. Based on its current production and expansion plans, the City believes the firm’s revenues will hit $409m in 2020, up from 2018’s $251m. Earnings per share are expected to more than double to $0.66, putting the stock on a 2020 P/E 5.

These numbers indicate that investors buying today could see an upside of 100% or more on their investment in Gulf Keystone over the next two years.

Undervalued

Genel’s comeback hasn’t been quite so impressive, but that shouldn’t detract from the fact that the stock appears to be undervalued by around 65%. At the time of writing, shares in this Kurdistan-focused oil producer are dealing at a forward P/E of just 5.3 (compared to the industry average of 8.7).

The business is also highly cash generative. After accumulating $241m of net debt by 2016, at the end of 2018, the group’s balance sheet had moved into a net cash position of $37m. Management is planning to use much of these resources to increase the company’s annual production, underpinning earnings growth over the next two years.

The drilling and exploration programme in 2019 has gotten off to a solid start with the business announcing today that the testing of its TT-20z well in the Taq Taq field (of which Genel has a 44% working interest) is complete. Production at the well has started at an initial rate of 2,000 barrels of oil per day. Production is also projected to increase over the coming weeks and months.

If the company continues to issue positive trading updates like these, I think it could only be a matter of time before the market rewards the stock with a higher valuation.

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Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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