US Edition Dana Petroleum
£14.50 +20
Questor says BUY
It's been a mixed year in Dana Petroleum's drilling programme. In September, the company plugged and abandoned its Trolla well off Norway after it was found to be dry. Yesterday, Dana also said that an exploration programme in the Gulf of Suez, Egypt, showed that its Nubia target did not contain hydrocarbon sands.
However, this is how it goes in the oil exploration industry; nothing is guaranteed. Drilling wells is always going to be a high-risk, high-reward proposition. That's what makes investment in oil discovery so exciting from an investment point of view. Some wells are dry and some are not.
Yesterday, we also learned about one that was not – and it could turn out to be a major discovery for the group. Dana revealed that it had made a hydrocarbon discovery at its Tornado offshore prospect west of Shetland. The group now has more hydrocarbon reserves than any other independent operator in the British North Sea. This is a good position to be in.
Dana has a 30pc interest in the Tornado well. Austrian group OMV is the operator, with a 35pc interest, Dong Energy has 20pc, Faroe Petroleum 7.5pc and Idemitsu E&P 7.5pc.
Dana recently revealed good progress at the Babbage field in the North Sea. German utility E.On, Dana's partner in the field, confirmed last month that the first gas platform had left its shipyard and was being installed in the area. Gas production is expected to start in April next year.
E.On is the operator of the Babbage field, with an equity share of 47pc. Dana has 40pc and Centrica subsidiary Centrica Resources owns 13pc.
This field is expected to produce more than 5bn cubic metres of natural gas over its lifetime, with a near-term production target of about 2m cubic metres of gas a day. This is enough to power 1,000 homes a year.
Results from another well currently being drilled in the Norwegian North Sea are expected in November, as the group began drilling the Jetta prospect on October 11. Egyptian prospect drilling will continue into next year.
The shares were recommended on April 7 at £12.00 and are now 21pc ahead of their recommendation price.
Questor considered putting a hold rating on Dana, as the share price approaches £14.99, the average target of the 21 City analysts covering the stock monitored by Bloomberg.
However, while not without risk, the company has a good portfolio of exploration assets and its production growth profile should boost the bottom line significantly over the next few years.
The shares are trading on a December 2009 earnings multiple of 36 times, which is undeniably high, but this falls to 17 next year, then to 14.9 in 2011 and 9.9 in 2012. Therefore, on balance, Questor has decided to maintain a buy stance.
BAE Systems
318.7p +1
Questor says BUY
Underlying trading at BAE systems looks pretty respectable, despite weakness in vehicle sales following the loss of a US contract to Oshkosh earlier this year. The company is appealing against the loss of this contract but there is the potential for write-downs.
Reassuringly, the group reiterated its guidance for the current year of "good growth" despite weakness and stronger cash flows in the second half.
Sterling weakness is also positive for BAE, as it is for all UK exporters, and this should help not only boost results in translation from foreign currencies, but should help keep orders buoyant. The group makes about half of its sales in dollars.
One issue investors need to keep a close eye on is the group's pension schemes. BAE made payments of £100m into the UK schemes and $250m (£162m) into the US pension schemes. However, there will be a one-time gain of $410m after restructuring of the US pension schemes.
The main issue when it comes to BAE is the current Serious Fraud Office (SFO) investigation into alleged corruption in Africa and Eastern Europe. This is what is keeping the price subdued – and the shares are trading at a discount to peers.
BAE reiterated the fact that it acted responsibly at all times, but does not know the level of financial sanctions that could be placed on it. The investigation is over allegations that it made secret payments to win key commissions in cases dating back to the 1990s.
Questor believes that any fine levied could be significant, but not crippling, and is still of the view that it does not affect the long-term prospects of the group. The company's management team has also changed substantially since the programmes under investigation were signed.
There is the prospect of legal proceedings, but it is more than likely that a settlement will be reached before its gets to this stage. The company has had this issue hanging over its head for a number of years.
The shares were recommended at 346½p on November 27 last year and they are now 8pc below their recommendation price.
The investment case for BAE remains sound. The shares are yielding 4.7pc and are trading on a current-year earnings multiple of 7.9 times.
This is at a discount to US defence company Lockheed Martin, for example, which is valued on a 2009 multiple of 10 times.
Once the SFO situation is rectified the shares will be re-rated. Now is a good time to buy.