Thoughts on Oil and Gas Companies (Part 1)

With the price of oil continuing to stay quite low and with oil shares trading at some of their lowest prices of the year, oil and gas shares (and their related services) may look like good purchases with their low P/E  and P/B ratio for long-term investors taking advantage of the downside of the cycle.

With a lot to talk about this topic, I'll be splitting this into two parts, the first part being this one and focusing on the financials of the oil and gas companies (focusing on Ezion and Ezra) and in the second part, discussing on the views of the oil price and other factors that would affect these companies.

(Image source: https://pixabay.com/en/oil-monahans-texas-sunset-106913/)

While oil prices have been falling since last year, which has reduced the prices of companies related to oil and gas such as Keppel, Ezion and Ezra, but not as much for Keppel as it is a conglomerate which derives its earnings from sources other than its oil rig business. This has attracted the attention of investors as who wouldn't appreciate a price that is only a fraction of the book value of the share for Ezra or a P/E ratio of under 5 for a company such as Ezion? For the purpose of simplicity, I'll be leaving Keppel out of this comparison due to its reasonably large presence in other industries such as Infrastructure, Property and Investments and focus on the other two, Ezra and Ezion

While these numbers look very nice on the surface, there may be a lot that is hiding underneath the surface that would allow these companies to be sold at such attractive valuations (other than the drop in oil prices). Let's look deeper......

Looking at the balance sheet, we can see that companies such as Ezion and Ezra have a high debt to equity ratio, above 1.1 for both companies. While their debt does not appear to have a high interest rate attached to it (they have low finance expenses for such large amounts), however, as interest rates rise, this would definitely squeeze their bottom lines. They also have perpetual securities in their equity, reducing the equity attributable to its shareholders, as well as some convertible preference shares and bonds, which would dilute the holdings (that being said, some of them were issued when the company was trading at much higher prices and are unlikely to be exercised)

Another issue is the capital-intensive nature of these industries, which have increased outflow of cash for purchasing more PP&E to allow the business to grow. Ezion used double its net income for the year in cash to purchase PP&E for 2014. Ezra used six times its net income for the same purpose in the same year. With the large investments into PP&E and a possible prolonged decline in oil prices, this would increase the depreciation and amortization costs to companies for the future years and require them to take up loans to fund these investments, leading to high debt to equity ratios.

As for their profits, we won't be able to see the impact of the drop in oil prices until a few years later when the oil prices start taking a toll and they get less contracts which would reduce both their top and bottom line. However, Ezra had a substantial decrease in profits in the second and third quarter of its financial year, but a surprisingly good first financial quarter, while Ezion has not seen a substantial drop in profits since the drop in oil prices.

This closes up this part on my views of the two oil and gas companies. Some of these characteristics may be present in other oil and gas companies as they share the same operating environment. The next post will include some of my thoughts on the more general factors affecting these companies such as oil prices and interest rates.

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