A toxic combination of management corruption and the falling price of oil has driven Afren (LSE: AFR) shares down by 71% so far this year, to 47p, the lowest level since June 2009.
Many shareholders are probably feeling pretty unhappy: management corruption is always a nasty surprise, and has compounded the effect of the falling oil price.
The independent report into the unauthorised payments made to former directors found that there was no material loss to Afren as a result of these transactions. Happily, the evidence we have seen so far suggests that the firms operations and the value of its assets have been unaffected by this scandal.
Whats more, analysts forecasts for Afrens earnings have not fallen anywhere near as fast as the firms share price.
Although last weeks sudden fall in the price of oil is not yet fully reflected in earnings forecasts for the next couple of years, its worth noting that Afren now trades on a 2015 forecast P/E of just 4.
Even if we downgrade next years earnings by another 20%, that still leaves Afren shares trading on a forecast P/E of 5, which looks cheap to me.
Potential upside before Q2 2015?
It seems clear to me that if Afren manages to deliver 2014 earnings anywhere near current forecasts, then Afrens share price could re-rate sharply. Similarly, any rebound in the oil price could lift Afrens shares quite quickly.
However, its important for investors to consider how the firms operations and growth plans might be affected if oil prices remain at current levels.
Is Afren still profitable?
In my view, Afrens operations should remain solidly profitable with oil at $70 per barrel: Afrens results for the first nine months show that it generated net cash from operating activities of $454.8m on sales of $798.5m, suggesting production costs of around $40 per barrel.
However, its clear that next years profits will be lower, and I wouldnt be surprised if the firm scales back some of its planned capital expenditure to prevent a cash crunch.
Is Afren a takeover target?
Afren currently trades at half its book value, despite the proven quality and cash generating potential of its assets.
As such, I wouldnt be surprised to see a bid emerge in the next few months. One possible candidate is Nigerian shareholder South Atlantic Petroleum Limited, which has built a 7% stake in Afren so far this year.
Even without a bid, I believe there are several factors that could drive a strong rebound for Afren shares over the next 3-6 months.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Afren. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.