Banks aren’t normal
Shares in Standard Chartered (LSE: STAN) have fallen by 60% over the last year. It’s been a painful experience for shareholders, including me.
Despite this, if Standard Chartered operated in another sector, I’d probably say it was a buy. After all, the shares trade at a discount of more than 50% to their book value. They also trade on a multiple of just 6.3 times their 2014 earnings.
The problem is that banks aren’t normal businesses. They’re very hard to understand. Standard Chartered’s bad debts rose by 87% to $4bn last year. We don’t know how much worse things will become.
Neither does the City, it seems. Broker forecasts for Standard Chartered’s 2016 earnings have fallen from $1.53 per share to just $0.25 per share over the last year. Given this, I’m not sure we can rely on current predictions that earnings will double to $0.57 per share in 2017.
In my view, Standard Chartered could double from here, but could equally continue to fall.
An oil stock that could double
Genel Energy (LSE: GENL) can breakeven with Brent crude at $20 per barrel — half the current oil price. Unfortunately, these ultra-low costs have not prevented the Kurdistan producer’s shares falling by 85% since May 2015.
Falling oil prices have depressed the shares of all oil companies. Things have been made worse for Genel because the firm is owed about $422m for past oil production. Genel also operates on the fringes of a major conflict.
Genel’s most recent lurch lower was in February. Following production declines in 2015, the company was forced to downgrade its estimate of proven and probable oil reserves for the Taq Taq field by almost 50%.
Despite all of this, Genel looks cheap by any normal measure of value. The risk is all political: will the war with ISIS spread into Kurdistan? Will the Kurdish government ever be able to pay its bills?
Genel could easily double, perhaps even more. But it could fall further too. This is a very speculative buy, in my view.
Is Tullow a better bet than Genel?
Unlike Genel, Tullow Oil (LSE: TLW) has quite diverse and low-risk production. Its customers usually pay their bills in full. The problem is that Tullow’s operating costs and debt levels are much higher. My particular concern is Tullow’s net debt, which has now reached $4bn.
I don’t expect this to cause the company to fail, but I do believe it could cause problems for shareholders. Tullow’s net debt is now 18 times larger than its 2017 forecast profits. We don’t yet know if the price of oil will rebound quickly enough to allow Tullow to repay its debts on schedule. If this doesn’t happen, then Tullow may be forced to raise fresh cash from shareholders.
In my view, this means that Tullow’s 2017 forecast P/E of 10.9 is not cheap enough to make the shares a buy. Debt repayments are likely to absorb all of the firm’s free cash flow, even when the market starts to recover. Gains for shareholders are likely to be very limited.
I may be too cautious, but in my view Tullow’s debt is a significant risk for shareholders. It’s not a stock I’d buy at the moment.
