Edmond Jackson's Stockwatch: Is SOCO International a surprise yield share?

It feels surreal to consider a FTSE Mid 250-listed oil and gas exploration and production (E&P) firm as a "yield share" - for such companies normally direct operational cash flow into exploration and acquisitions to maximise long-term shareholder value.

Over twenty years ago, I recall the request for a dividend by shareholders at the AGM of Premier Oil being brushed aside.

Despite this mid-cap E&P share sporting a strong record of cash generation, only now do forecasts suggest Premier will pay a maiden dividend for 2013 onwards - a scant yield of 1.8%.

Any previous shareholders in Dana Petroelum (before it was acquired) may recall its chief executive dismissing dividends as fundamentally inappropriate.

Indeed when I have drawn attention to the FTSE Mid 250 shares in SOCO International, it was for capital growth prospects just below 300p in April 2012, similarly after strong 2012 results last March at 385p.

I did not expect to be re-appraising SOCO as a radically bold income share, with upside potential also from a circa 10% yield being under-priced and the scope for any of various projects to impact value.

Yet its 29 August interim results showed net cash and liquid investments up from £140 million equivalent to £225 million, year-on-year to end-June, helped by a 40% rise in production to an average 17,135 barrels of oil equivalent per day, and a halving of capital spending needs.

There was also a proposed return of 40p a share (equivalent to £133 million) with subsequent returns targeting 50% of annual free cash flow (my emphasis for astonishment).

This distribution was made on 14 October although SOCO has traded broadly sideways as if the market has yet to take this in or wants more evidence that cash flow is sustainable.

For context, the table shows how cash flow per share has turned well in excess of capital expenditure also earnings; and despite its recent bumper payout, SOCO's latest 19 November Interim Management Statement declared net cash and liquid investments of about £125 million equivalent at 15 November. So this radical strategy is firming up.

It said: "By continuing its disciplined approach to the allocation of capital, the company is comfortably positioned to continue an annual return of cash to shareholders and to also retain exposure to a high potential exploration programme."

For E&P investors, it's as close as it gets to having your cake and eating it.

Risk

If stockmarket pricing is reasonably efficient then it is surprising SOCO has not re-rated further. This implies caution to whether long-term earnings may vary and what operational/locational risk may be involved.

If the former US Treasury Secretary is correct in predicting secular stagnation then oil prices could trend lower. Much depends whether loose monetary policy by central banks, from America to Japan, improves underlying economies hence energy demand.

There is also political and economic risk in Asia Pacific such as ongoing tensions between Japan and China over islands in the East China Sea and excess credit in the Chinese economy; issues that would disrupt the region if they erupted.

SOCO's revenue also derives principally from the Te Giac Trang (TGT) and Ca Ngu Vang (CNV) production fields in Vietnam, which is relatively high focus.

SOCO's clarified risks and uncertainties include: "Empowerment risk - the conduct of international operations requires the delegation of a degree of decision-making to partners, contractors and locally based personnel."

More positively regarding TGT, management asserted at interims: "It is as yet early days in the overall field development with four to five appraisal wells and multiple completions scheduled over the coming years."

So it may essentially be a matter of time to prove a track record for this bold strategy: if SOCO can prove a 50% annual return of cash flow at all sustainable and grow assets via the drill bit, then risk is significantly on the upside.

Unless oil prices plunge, a high payout policy ought also to reduce the inherent volatility of an E&P share - for example relative to "risk-on, risk-off" mood swings in the market, additional to commodity price swings. Theoretically this in itself argues for a premium rating.

So there is potentially a lot to play for here, the market may be disregarding because it doesn't fit the normal sense of an E&P company.

But it ties in with my overall observation in April 2012: SOCO then looked as if it was advancing its projects well, profits were kicking in and the directors had increased their already substantial equity exposure.

A point to mind regarding the 'market consensus' forecast, which from the table looks very odd how 2014 earnings per share is expected to advance by about 30% with 8% growth in profit: individual brokers' forecasts look to be all over the place and don't make sense anyway, a proverbial case of 'garbage in, garbage out'.

You can see clearly from SOCO's reporting, it looks well positioned to progress.

For more information visit socointernational.co.uk.