http://seekingalpha.com/article/...co-energy-dont-expect-a-turnaround
EGY's revenue, margin, and cash flow have taken a beating in the past year on account of lower oil prices as it does not employ hedges to protect its production.
Oil prices can go lower due to the Iran nuclear deal and Saudi Arabia's constant increase in the oil output, creating more headwinds for EGY.
Surprisingly, EGY is focused on increasing production despite the fact that its cash flow and margins have dropped sharply, indicating that its assets are not cash flow positive.
VAALCO Energy (NYSE:EGY) has seen a huge drop in its stock price in the past year, having lost more than 75% of its value. This is not surprising, as the weakness in oil and gas prices has wreaked havoc on the company's financial performance. In fact, when VAALCO had released its latest set of results, its revenue was down 35% from last year while net loss had increased more than five times.
This was the result of a 55% decline in the realized price of oil last quarter, and VAALCO didn't have any protection against this drop as its production was unhedged. Looking ahead, it is likely that VAALCO will continue struggling on account of more weakness in oil and gas prices. Let's see why.
Increasing production from OPEC and the Iran deal will keep oil prices under pressure
Saudi Arabia, the largest member nation of OPEC and the biggest crude oil exporter in the world, is pumping up production in order to meet an expected increase in demand for OPEC crude. As a result, in June, Saudi Arabia pumped 10.564 million barrels per day, setting a new production record in 35 years. In fact, Saudi Arabia has been constantly increasing its production in order to keep its market share in the oil industry intact and force the hand of U.S. shale oil drillers into reducing production.
As a result, Saudi's oil production has increased consistently of late as shown below:
(click to enlarge)
Source: Bloomberg
Looking ahead, it is expected that OPEC will continue raising oil production as it foresees an increase in demand to the tune of 0.9 mb/d to average 30.1 mb/d in 2016. On the other hand, the recent Iran nuclear deal could also exacerbate the oversupply situation in the oil industry next year. Yesterday, the U.S. and the EU reached a deal with Iran that will allow the country to export its oil in return for curbs imposed on the nuclear program.
Now, this might give rise to more pricing pressure in the oil market since Iran has the fourth-largest oil reserves in the world. According to Vox:
"Even if all goes according to plan, the US and EU won't lift sanctions on Iran until 2016 at the earliest. Once that happens, Iran can finally start selling some of the roughly 30 to 37 million barrels of oil it currently has stored in vast floating tankers off its coast. That could push down, modestly, on oil prices."
Thus, there seems to be no end to the uncertainty around oil pricing.
VAALCO's moves won't bring it any relief
Despite an oversupply in the oil market, VAALCO is busy expanding capacity and production. Recently, the company drilled and concluded two wells on the innovative Etame platform, offshore Gabon. The initial production from the Etame 10-H and Etame 12-H wells were recorded in February and April 2015, respectively.
The Etame 10-H well delivered production at an initial rate of about 3,000 BOPD. Moreover, the Etame 10-H well now has an un-drained lower lobe of the Gamba reservoir in this fault block, which is believed to have nearly 25 million gross barrels of production capacity. Additionally, the Etame 12-H well was successfully completed in the beginning of the second quarter of 2015 and started production early in April 2015 at an initial rate of about 2,000 BOPD.
In fact, VAALCO has improved its offshore Gabon production capacity by 30% since the fourth quarter of 2014 using these two wells. But, in my opinion, this is not the right thing to do as VAALCO's production is hardly profitable. The company has a negative profit margin of more than 92%. This is not surprising, as VAALCO has seen a massive drop in its gross margin over the past year. In fact, VAALCO's gross margin had started dropping even before the weakness in crude oil prices reared its head:
EGY Gross Profit Margin (<a href=
EGY Gross Profit Margin (NYSE:TTM) data by YCharts
Also, as can be seen in the above chart, VAALCO's cash flow from operations has also dropped quite sharply in the past year. As such, the company does not seem to be doing itself any favors as oil prices could continue dropping going forward. Since VAALCO's assets are not cash flow positive, as seen in the chart, its fundamental performance could continue declining.
Conclusion
VAALCO has weak margins, its cash flow has dropped considerably, and oil prices could drop further. These points indicate that VAALCO Energy's stock could drop further going forward, which is why investors should stay away from this oil and gas company.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
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