What the City thinks of Afren

With Afren's chief executive and chief operating officer suspended for allegedly benefitting from unauthorised payments, the City is taking no chances and the oil explorer's share price has plunged by almost 30%. But with the underlying business apparently unaffected by the shenanigans, there are some who think this could be a great buying opportunity.

Admittedly, bargain hunting on Monday morning provided only a brief respite, and further selling during the afternoon session left the share price at just 107p, a two-year low. Those multi-year highs registered in December seem an age away.

And the conclusion of an investigation or release of Afren's delayed interim results is unlikely to happen any time soon. Analysts at JP Morgan estimate that the debacle has lost around $700 million (£416 million) of shareholder value. "In a sector which has been struggling to find friends, this is the last type of news it needs," said the broker.

But Marc Anis-Hanna, an oil & gas analyst at VSA Capital, told Interactive Investor that he thought the market had acted irrationally to the news.

"We think the market has over reacted, valuing the potential financial impact of possible fines (there is nothing affecting the company operationally) at around £400 million Afren was appealing before this negative news and is now even more attractive in our view as it is trading just below its core NAV [net asset value] with potential for more Nigerian production coming on stream during the year."

Interactive Investor also hears that a large number of brokers have been buying shares for their customers with a high-risk tolerance.

"The company assets are worth more than the current valuation, plus the very low market cap opens some room to possible takeover of Afren by another firm," adds Anis-Hanna. "Therefore, at these levels I see more positive upside rather than negative, including the legal risk which has obviously been taken into consideration into the share price."

Underperformance

A week before the announcement, Afren had underperformed the European exploration and production sector by 10%, posting total returns in the year so far of 13%, "triggered...by a relative dearth of well results and lighter-than-anticipated production in the first-quarter of 2014, casting some doubts on Ebok production potential," said James Thompson at JP Morgan.

He was ready to take advantage of any negative share price reaction to the, now-delayed, interim results, anticipating that weaker production results would drag down the share price. He pencilled in first half production of 36,000 barrels of oil per day (boepd), from 35,500boepd in the first quarter, and revenue in the period of $600 million, assuming a Brent crude price of $109/bbl. Gross profit was expected to be down 34% year-on-year to $247 million and pre-tax profit down 37% to $164 million. These numbers don't look good, but Thompson was confident of a better six - nine months ahead; with re-risking of discovered resource, particularly in Nigeria - one of 2013's stand-out discoveries - and news on Ain Sifni in Iraq.

Assuming no impact on net asset value (NAV), Afren is trading at a discount of around 26% to core NAV, "the lowest level since mid-2012", added Thompson. Although this has triggered take-over speculation, Thompson expects "potential predators" to await the investigation outcome before pouncing. That would seem sensible.

While Investec downgraded Afren to 'hold' and put its target price under revision, others upgraded or reiterated their positive stance on the company. JP Morgan stayed 'overweight' and Westhouse Securities reiterated its 'buy' recommendation.

Westhouse said: "This does not affect the operations and financials of the company. We note that this independent investigation was executed on behalf of the board and very little detail is known, but the payments were not made by Afren.

"Until there's more clarity on the issue and further steps by the board, the stock may be volatile. But this may be a sign of improving corporate governance and we will wait for the outcome of the investigation. Fundamentally, the company has a self-sufficient business in Nigeria and promising set of assets in Kurdistan."

Whether investors take advantage of this share price dip depends on their risk/reward profile. Remember, bargain hunting pushed up the share price Monday morning, but reversed later in the day. Afren shares will remain incredibly risky. True, if there's no impact on net assets, the shares might look cheap, but all analysts agree we need more information. When it comes - and it will - the shares will either rally hard or sink like a stone. We'll find out soon enough.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.