The oilrouthas thrown up plenty of opportunities for the long-term contrarian investor. However, trying to pick the companies that have the best outlooks, while avoiding those that could be destined for the scrap heap is never an easy job.
Indeed, three of the UKs premier small/mid-cap oiliesPremier Oil (LSE: PMO),Tullow Oil (LSE: TLW) andGenel Energy (LSE: GENL) all look cheap at current levels. But if you start to trawl through the numbers, it quickly becomes apparent that only one of these companies is worth investing in right now.
It all comes down to cash
Theres no doubt that Premier, Tullow and Genel are all good quality companies with high-quality production outlooks and a record of success.
Nevertheless, as weve seen over the past two years, the oil market can be extremely unpredictable and,for this reason, the companies with the strongest balance sheets make the best investments in the sector.
A cash-rich balance sheet is almost a necessity for a commodity-focused company that has to ride out cyclicalmarkets. Without a suitable level of cash on hand, oil producers can be backed into a corner when the oil price falls, and the producers can be forced to take drastic action to pay-down debt.
Debt is deadly
Genel, which is run by one of the most experienced management teams in the oil industry, knows that a cash-rich balance isthe keyto success. The companys cash balance at 31 December 2015 stood at $455m and net debt stood at a respectable $239m. Almost all of the companys debt is linked to one bond issue, which matures on 14 May 2019.
On the other hand, Premier and Tullow dont have the same balance sheet flexibility as Genel. At the beginning of November, a group of City analysts warned that without a recovery in oil prices, Premiers shares were worth almost nothing as the value of the companys assets is currently insufficient to pay off existing debt. Based on the analysts calculations, which were put together back in November, higher interest payments were set to absorb nearly all of Premiers free cash flow going forward, leading to the postponement of new developments. This forecast is out of date as Premiers agreement to pay $120m for Eons cash-generative North Sea assets in January will give the company more flexibility, although the groups weak balance sheet will continue to limit its options.
Meanwhile, Tullows debts are getting out of control. Tullow City analysts have predicted that the companys net debt will hit $4bn by the end of December, against pre-tax profits ofonly68m for full-year 2015 and 142m for full-year 2016. By taking on debt, Tullow was able to become one of the UKs most prized oil companies before the crash in 2014, but now the debt has come back to haunt the group and its not clear how much longer Tullow can continue to live beyond its means.
The bottom line
So overall, with its robust cash balance and strong management, Genel is my oil stock of choice.That said, even Genels outlook is at the mercy of the oil priceand with this being the case, there are better non-oil opportunities out there.
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