Is Serica Energy’s share price undervalued?

Serica Energy’s [SQZ.L] share price rally has cooled in recent months, but a rejected merger with UK-based energy industry investment company Kistos [KIST.L] and strong fundamentals suggest the North Sea natural gas producer’s stock could be undervalued. 

Serica Energy’s stock has benefitted from both rising gas prices and energy security fears. However, the share price has sunk 22% over the past three months, closing Friday 15 July at 323p.

Weighing on sentiment is the UK government's introduction of a windfall levy on oil and gas producer profits. The energy profits levy is charged at 25% and takes Serica’s headline tax rate up from 40% to 60% on profits made after 26 May.

Unsurprisingly, news of the levy caused a steep selloff in the stock. While some of the losses have been recovered, it is still trading below its 52-week high of 423.5p hit on 13 April. Aside from additional taxes, a drop in natural gas prices is unlikely to have helped sentiment.

However, the beginning of July saw a rally in Serica’s share price and, after what has been a couple of tough months, investors will be hoping this positive trajectory continues.

Tailwinds for Serica’s share price

Serica Energy’s share price jumped nearly 14% when its board announced it had rejected a merger proposal from Kistos. The proposed merger valued Serica at £1.04bn, with Kistos offering a cash and stock offer that represented a 25% premium on the share price.

Stifel analyst Chris Wheaton said that he did not think the offer represented good value for Serica’s shareholders, noting that the cash element of the deal would be largely funded by Serica’s own cash.

In further good news for investors, Serica started drilling operations at the North Eigg exploration well in the Northern North Sea. If successful, the well will provide low-emission gas for the UK market between 2025 and 2035. The drilling will use Serica’s existing Bruce platform, reducing the investment needed to develop new facilities.

Alexander Stahel, a fund manager at Swiss-based investor Burggraben, said that investors would be paying close attention to developments at North Eigg as Serica fully owns the well, meaning it doesn’t have to split profits.

Undervalued, but financially sound

The Kistos offer suggests that Serica could be undervalued. It valued Serica well above the company’s market cap of £878.4m. The stock also trades at a relatively cheap forward price-to-earnings ratio of 3.1, according to data from Yahoo Finance.

Fundamentally, the business is in good shape. Serica’s profit after tax came in at £79.3m in 2021, up from £7.8m the previous year. Revenue in 2021 also rebounded strongly with sales totalling £514m, up from £125.6m the previous year.

The bounce back in profits has much to do with gas price volatility. To protect against any fall in prices Serica built up cash resources of £218m in 2021, up from £91m the previous year. The company also ended the year with no borrowing on its books. For income seekers, Serica carries a healthy 9p per share payout in 2022, up from 3.5p the previous year.

Where next?

Any investor considering Serica’s share price should be aware that it is susceptible to volatility in commodity markets. In the company’s 2021 annual report, executive chair Tony Craven Walker notes that “forecasting and planning in the industry is extremely difficult”. He also underlines the importance of the UK’s own domestic resources and the publication of the British Energy Security Strategy, which Walker suggests will encourage investment in companies operating in the North Sea.

A combination of further exploration in the North Sea and rising prices could benefit Serica’s share price, but nothing is guaranteed.

Of the three analysts polled by Refiniv, Serica’s share price has a median target of 395p, suggesting a 22.3% upside on Friday’s close. All the analysts polled have a ‘buy’ rating on the stock.