Recent stock market falls are understandably worrying for many investors. But I reckon it’s a mistake to focus too much on the short term. The former penny stock I’m looking at today has risen by more than 1,000% over the last five years. The recent market wobble hasn’t made much difference to that gain.
Since February 2017, this investment has turned £1,000 into more than £11,000, including dividends. That’s a potentially life-changing profit. Some investors think this share still looks cheap. I’ve owned this stock before but sold my shares too soon. Should I buy back in today?
Winning with oil and gas
The company in question is North Sea oil and gas producer Serica Energy (LSE: SQZ). Chief executive Mitch Flegg oversaw a transformational deal with BP in 2018, when the company bought the Bruce, Keith and Rhum (BKR) fields in the North Sea.
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This acquisition made Serica a substantial North Sea producer. Over the last year, the group has been perfectly positioned to benefit from surging oil and gas prices. More than 85% of Serica’s production is gas, and the company supplies around 5% of total UK gas production.
Broker forecasts suggest that Serica will report a profit of around £200m for 2021, compared to £64m in 2019 and just £8m in 2020.
I’ve been a fan of Serica for a while. In my view, this is a well-run business with strong finances. I certainly regret selling my shares in October last year — the stock has risen by another 20% since then.
Is this former penny stock still cheap?
I think Serica shares could still be cheap. But there are a couple of things about the company’s valuation that make me cautious.
First of all, the shares are currently trading on a price/earnings (P/E) ratio of just three times 2022 forecast earnings. That’s unusually low, even for a fossil fuel stock. BP, for example, has a forecast P/E of seven.
My second concern is that Serica’s dividend is unusually mean. The group’s net cash balance was £218m at the end of 2021. Earnings of 82p per share are expected for the year — a record high. Despite this, broker forecasts suggest the 2021 dividend will be just 3.5p per share, giving a measly 1.6% dividend yield.
These numbers suggest to me that the market doesn’t believe Serica’s profits are sustainable. I share this view. At some point, I think that lower oil and gas prices plus rising decommissioning costs will cause Serica’s profits to plummet.
I also get the feeling that Mr Flegg is holding on to the company’s cash because he expects to need it in the future. My guess is that Serica’s big cash pile is being earmarked for decommissioning costs and — perhaps — for acquisitions to replace the BKR fields, when they start to decline.
Serica share price: my decision
I think Serica is a good business and I admire what chairman Tony Craven-Walker and CEO Mitch Flegg have achieved. It’s possible that the two men will continue to expand this business, rewarding shareholders.
However, I just don’t think the shares are as cheap as they might seem.
In my experience, buying commodity producers when commodity prices are high is often a bad idea. Although I think Serica’s profits may rise this year, I suspect they will fall from 2023 onwards. On balance, I think it’s probably too late for me to buy.
