Serica Energy: A Super Stock With A 9% Yield

14th Nov '23 by Roland Head

28 comments 4465 reads

This North Sea oil and gas producer currently trades on a forward price-to-earnings ratio of three and boasts a 9% dividend yield. There’s a healthy cash pile as well.

We’ve covered this stock here before, but much has changed over the last 18 months, including the acquisition of Tailwind Energy.

Stockopedia’s algorithms rate Serica Energy (LON:SQZ) as a Super Stock. I think it’s a good time to take a fresh look at this business.

Summary

Pros:

Cash-rich group with low-cost production assets in the UK North Sea
Specialist in operating and improving the performance of ageing fields
Tailwind acquisition has improved asset diversity and resulted in more event split between oil and gas production
Seemingly modest valuation on three times earnings, with 9%+ dividend yield
Experienced management, supportive main shareholder

Cons:

Many of Serica’s assets have limited lifespans
Minimal hedging means a high level of exposure to commodity prices
There’s no guarantee continued reserve replacement will be possible at attractive costs
Risk of Serica ‘diworsifying’ into international operations and losing money
Decommissioning liabilities may be greater than expected
Net cash position may partly reflect the need to provide for future liabilities

Profile

About the stock

Serica Energy is an independent oil and gas producer operating in the North Sea. It operates in the Energy sector and is part of the Oil & Gas industry group.

Serica was founded in 2004 and floated on London’s AIM market in 2005. Today it has a market cap of £850m and a recent share price of 220p.

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The StockRanks show high quality and value scores for Serica, with improving momentum. This suggests that the business might potentially be in a sweet spot of improving performance and attractive valuation.

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About the opportunity

Earlier this year, Serica Energy completed the acquisition of privately owned North Sea firm Tailwind Energy . This resulted in a 75% increase in Serica’s reserves and a significant increase in oil production.

Serica’s production is now split 55%/45% between gas and oil respectively, whereas it was previously 90% gas. In the UK market at least, gas prices tend to be far more volatile…

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Ned Kelly

14th Nov '23

A good article but you make relatively little mention of the UK Excess Profits Levy (EPL), which is in place until 2028 under the present rules and Rachel Reeves threatens to make worse under a Labour government. This, I believe, is the real reason that @SQZ trades on such lowly multiples. Without it the price would be much higher.

ISAallowance

Yes, I agree, the two tranches of windfall taxes have really taken the shine off the price.

The first 25% windfall tax came into effect from 26/5/2022, the additional 10% levy from 1/1/2023. Labour have stated in the past that if they come to power they will retrospectively apply the first windfall tax from 1/1/2022, i.e. covering an additional 5 months which saw very strong gas prices. I don't know if that remains their position, and personally I think they'd probably quietly drop a retrospective tax after getting elected, but it can't be helping sentiment.

bullhead

15th Nov '23

Agree with Ned below personally think you are underestimating the political risk as set out in quotes and articles below no new oil licenses and increased tax

https://www.theguardian.com/bu...

https://www.theguardian.com/po...

https://www.bbc.com/news/uk-sc...

Energy is about to get a lot more political involvement in a years time with the new Labour government

portugull

Ned Kelly can I point out that Mitch Flegg CEO of Serica Energy (LON:SQZ) pointed out on 19 Sept that the Tax Losses inherited from the Tailwind Merger would significantly mitigate the Tax paid by Serica. I think he said that that the actual rate would be 55% which is a material reduction. Taken from my notes on the 19th Sept and subject to checking and I stand to be corrected.

G Morris

Held until the awful reverse takover by Tailwind that benefitted the board and not smaller shareholders. Awful deal doubling down on the North Sea knowing government policy was not to encourage production in the UK. Moved to Canadian and even Brazilian oil stocks with their much longer decades of reserves, low extraction costs and good dividends and no 75% levy on any profits.

Olly Daney

Hi Roland thanks for a brilliant article, it’s great to read such in depth research on a particular stock. Found the paragraphs on risks, valuation and profitability helpful. I have also wrote a piece on Serica energy as part of my own research . I’ve posted it to the discussion section for Serica if you or anyone else would like to read it.

peter100hr

16th Nov '23

If you click the up symbol ^ to the right of HBR it will show a list of Securities mentioned: SQZ is is listed just under HBR.

I think that all the variables that are outside management control make SQZ a share to trade, not to (plan on) holding long term. It's been in a downtrend since Aug 22 and regression analysis implies this may continue, with a potential low around 180p, which is where I've set my buy target.

Rusty2

It was not, that why I posted about it, it was added later. It also did not come up in a search on Serica Energy (LON:SQZ) . See also Roland's reply to my post.

Martin VT

I note Roland's comment about 'ultimately falling demand for fossil fuel'...if thinking in terms of the next 15-30 years, we know that the trend for the last 30 years has been increasing demand for fossil fuel, despite all the talk and trillions spent around the world on the so called 'energy transition'.

Whatever other factors govern the SQZ price, I really doubt a lack of demand will be a factor.

Peter171

20th Nov '23

I have been of the same mind, why have the worries of an unstable tax regime . My oil interests are scattered around the world excluding the uk.

MichaelFBS

21st Nov '23

Thank you Roland for excellent analysis. I have been thinking about Serica Energy (LON:SQZ) since John Rosier bought it for his JIC portfolio, which was quite sometime ago so I suspect he is sitting on quite a nasty draw down. (I no longer subscribe, just too many subs going out).

I have another high yielding low PE stock (Sylvania Platinum (LON:SLP) ) in my portfolio and while the divis are lovely when they come in I would be happier if it went to a 10 or 12 PE!

Sometimes negativity on a stock, a sector, a geography is so entrenched that almost nothing bar a take over or the second coming will make it re-rate.

In my opinion oil and gas have a very long future. I have recently read How the World Really Works by Vaclav Smil and if you buy in to his thesis, oil and gas are with us for a very long time. (How we solve the carbon problem is another issue). For example there are approximately 1.2 billion cars in the world, of which 10 million are EV. That proportion is not going to change significantly for a long time. Much more compelling but less simple arguments apply to steel, concrete and food production. (It is like smoking. It might, if you are a European, seem as though tobacco is doomed, but there are 1 billion smokers in the world, who are probably not giving up any time soon. I do not hold and never would, big tobacco).

The reality is that the modern world needs and will always need, for the foreseeable future, oil and gas.

I am almost certain I will take a small position and see how in goes from there.

Regards

Michael

KevinS1

Hi Michael,

FWIW, I have been a significant holder in Serica Energy (LON:SQZ) for about three years (buying in originally around £1). I have sold & bought a lot of times during that period - I am very regretful that I did not sell out at its peak of around £4, but in all honesty it still remains my biggest holding (across all of my accounts) and it seems to still be extremely cheap.

I enjoy getting the large dividends whilst I wait for the price to come back (not sure it will hit £4 again), but am very happy - if I wasn't so heavily invested I would happily buy more.

When I say "heavily" its probably not that big compared to those that happily hold their biggest investments at 10-20%+ of their PF, but it seems a lot to me (probably about 8-9%).

The investment case seems to continue to be strong and even with the super-tax I still see them throwing off loads of cash - plus they have the Tailwind tax losses to help with this.

I cannot see O&G consumption being impacted for years to come and I see plenty of opportunities for good operators to keep growing - not always in the UK, but I do expect energy security to become a bigger issue in the next couple of years when the MP's finally wake up to the reality.

5th Feb

Don't know if anyone reads these old share tips, but back in November ('23) I commented on here that my technical analysis indicated a target (closing) price of 180p for Serica. It's now hit that target (overshot slightly), and my analysis is still indicating 180p. Although the price chart hasn't yet generated a buy signal, the buy price looks pretty close.

sevenccc

6th Feb

Short term the price of UK Gas per therm has dropped to 70p and according to Trading Economics will trade between 77p and 90p from the end of this quarter to end of year. Oil on the other hand is running ahead of what they achieved for a first half.

Given the slight weighting to Gas means H2 revenues will probably be c 10% lower. So dividend forecast drop to 20p seems reasonable to me. Still over 10% on current disappointing sp.

Did I miss any reference to the latest Farm In with JOG/Shell? Implications of this should extend life of producing assets

Would expect Labour to remove much if not all of the Investment Incentive almost on Election. Difficult to justify greater subsidy for investing in O&G sector over renewables in current climate, one would think.

kuronagi

My broker passed me yesterday’s update notes from Jefferies (target price 280p) and Peel Hunt (target price 351p). As a retired analyst, head of research etc etc, I don’t put much value on stockbroker research having written many similar notes myself! But as a very longstanding holder of SQZ (over 10 years) and with a large holding, I opted to add to my holding yesterday.

rmillaree

, we know that the trend for the last 30 years has been increasing demand for fossil fuel, despite all the talk and trillions spent around the world on the so called 'energy transition'.

ultimately it may be horlocks but at least some are confident things may change within the next decade

https://www.iea.org/news/the-e...

The combination of growing momentum behind clean energy technologies and structural economic shifts around the world has major implications for fossil fuels, with peaks in global demand for coal, oil and natural gas all visible this decade – the first time this has happened in a WEO scenario based on today’s policy settings.
hmmmm caveat who are the IEA and are they talking their own shop up ? i suspect they may be.

OldSchool05

Thanks Kuronagi, interesting to see your comment.

My main concern here is the cash flow appears to have disappeared, and net cash at year end dramatically lower than at the interims. The other thing I noted was Mitch Fleggs tone, where he had previously emphasised the strong cash flows of Serica but not mention in this update. I hold, and added this morning too as it appears oversold

af20001

8th Feb

Some of the directors have been dipping their toe in this week since the drop. Good to see.

20th Feb

As Serica is again re-visiting the 180p region I thought I would update my Feb 5th analysis - that Serica had hit my (Nov '23) 180p target buy price, but had not yet generated a buy signal.

As of today, it has still not generated a buy signal. My TA target has moved down slightly to 179p, and is indicating that the price is unlikely to clear the 180p region for another month or so.

Serica Energy: a super stock with a 9% yield

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Roland Head

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