Fantasy Yesterday, Reality Today

Monday, 29th September 2014 09:39 - by Moosh

My previous blog post at the back end of 2013 questioned whether fantasy can turn into reality with respect to picking an undervalued company to invest in based on something as simple as the price to earnings (PE) ratio (amongst other factors).

¹ After nearly a year of incubation, it seems, in this case for Empyrean Energy (TIDM: EME), that fantasy does indeed become reality. As of the full year results to March 2013, the earnings per share (eps) for EME were ~0.93p, so assuming a fair value range for share price exists between a PE ratio of 10-20, then it yields a fair value price range of 9.3p to 18.6p.² EME was waiting for a trigger item of news to get things moving and this came in the form of the interim results in December, 2013. Since then the price has appreciated all the way to 20.75p – the recent highs of 20p+ over summer being attained when the company began a strategic review of operations and initiated a formal sale process, which has now been closed to further bids.^3-4 During this period of time, operations have been to plan and there has been a reasonable level of stability to allow the price to rise gradually, without excessive volatility created by traders’ antics.

The latest results for the year ending March 2014 presented the eps of 2.37 cents (~1.47p), suggesting a fair value range of price to exist between 14.7p and 29.4p.⁵ The current price has been hovering in the 18p to 20p range and I daresay that an upward breakout in price towards the top end of the fair value range is unlikely to happen while the company is in this deliberation period of considering any offers for EME or its Sugarloaf asset, but if these offers do not come to fruition and proceedings return to ‘normal’, then there remains the potential for a move up to the 25p+ region based on the recent earnings. The latest operations update stated that Q2 production is lower compared to 2013 but it also went on to mention a boost of at least 26 wells coming into production from July to September, 2014, as well as 28 more wells which are at various stages of drilling/completion which, I would have thought, should come into production during October-December 2014.⁶ This year has also seen Marathon Oil begin to assess the potential of the Austin Chalk (AC) layer at the Sugarloaf Block B project and flow rates from test wells have been similar to those from the Eagle Ford Shale (EFS) – Marathon will be trialling a ‘stack-and-frac’ programme from October 2014 to co-develop the EFS and AC too. On the face of it, more wells will be brought into production during financial H2 compared to H1, so I would expect any growth in production to be weighted to H2 and therefore have more of an impact on the full year results to March 2015 rather than the interim results.

Interestingly, it appears the market makers have a good grasp of how to make the market for EME according to its fundamentals since the PE ratio at the end of March 2014 (for the most recent full year eps of ~1.47p) was about 10 – at the very start of fair value. If you consider the fact that the results to March 2014 weren’t released until September, 2014, then the market makers were spot on in their judgement of where to put the price and set the trend....but then, that is their job.

References:

1. http://www.lse.co.uk/blogs/member/moosh-blog/2tixzq/
2. http://www.lse.co.uk/share-regulatory-news.asp?shareprice=EME&ArticleCode=sxjvjhy6&ArticleHeadline=Final_Results
3. http://www.lse.co.uk/share-regulatory-news.asp?shareprice=EME&ArticleCode=c4ash3gc&ArticleHeadline=Strategic_Review
4. http://www.lse.co.uk/share-regulatory-news.asp?shareprice=EME&ArticleCode=1lrtxrbc&ArticleHeadline=Update_on_Strategic_Review_and_FSP
5. http://www.lse.co.uk/share-regulatory-news.asp?shareprice=EME&ArticleCode=pkrjjv91&ArticleHeadline=Final_Results
6. http://www.lse.co.uk/share-regulatory-news.asp?shareprice=EME&ArticleCode=w3rp1uub&ArticleHeadline=Q2_2014_Production_and_Operations_Update