The Better Oil & Gas Stock: Sembcorp Marine Ltd vs. Sapura Kencana Petroleum Bhd

It’s no secret that companies with businesses in oil and gas are having a rough time. With the price of oil falling from over $100 per barrel in mid-2014 to around $40 today, companies across the entire value chain of the oil and gas industry are mired in a weak business environment.

This hasn’t escaped the notice of the stock market, with the shares of many oil and gas companies having suffered painful declines since the start of 2015 (some oil-related stocks in Singapore have even dropped by 80%!).

But, the sharp falls may bring about opportunities for enterprising investors. With this in mind, let’s take a look at two of the biggest oil and gas companies in Singapore and Malaysia, namely Sembcorp Marine Ltd (SGX: S51) and Sapura Kencana Petroleum Bhd (KLSE: 5218.KL), to see which may present the better investing opportunity.

Company Market capitalisation
Sembcorp Marine S$3.8 billion
Sapura Kencana RM12.5 billion

Source: S&P Capital IQ

It makes sense for Singaporean investors to look at Malaysia as well, given the close ties both countries have with each other. Also, the Malaysian stock market, with around 1,800 companies in it as opposed to the 771 in Singapore’s, helps widen the opportunity set for investors here.

Some useful things to compare between the two companies are their valuation numbers (things like the price-to-earnings and price-to-book ratios), returns on equity, ability to generate free cash flow, and balance sheet strength.

Before we start, I’d like to have a few words on the business of Sembcorp Marine and Sapura Kencana for some additional context. The two companies are not in the same business; Sembcorp Marine builds rigs and vessels whereas Sapura Kencana owns offshore assets that provides various types of services to the oil and gas industry.

In this sense, Sapura Kencana can be seen as a type of company that could possibly be a customer of Sembcorp Marine. But, both are clearly plugged into the whole oil and gas scene and their businesses have a strong dependence on the price of oil.

With that, let’s dig into the important financials that we’re interested in.

Valuation numbers

The stock market works in a simple manner: You can stack the odds of success in your favour if you buy stocks when they’re cheap and hold them over the long-term. This is where valuation numbers come into play; it wouldn’t make sense to overpay for a stock.

Based on its latest financials and current stock price of S$1.805, Sembcorp Marine is valued at 8.9 times its trailing earnings and 1.26 times its book value. Meanwhile, Sapura Kencana, with its latest share price of RM2.08, has self-same figures of 14.8 and 0.98, respectively.

On the basis of earnings, Sembcorp Marine would be the cheaper stock. And since the company’s not priced at much of a premium over its book value either, Singapore’s representative comes out tops here.

Return on equity

The return on equity figure measures how much profit a company can generate with each dollar of shareholder’s capital it has.

It is also a good gauge of management’s abilities. To the point, the legendary investor Warren Buffett once wrote that he believes “a more appropriate measure of managerial economic performance to be return on equity capital.”

You can see how Sembcorp Marine and Sapura Kencana’s returns on equity have been in the last 12 months and over their past five fiscal years (Sembcorp Marine’s fiscal year coincides with the calendar year, meanwhile, Sapura Kencana’s fiscal year ends on 31 January):

Sembcorp Marine and Sapura Kencana - returns on equity
Source: S&P Capital IQ (click chart for larger image)

As the chart above makes obvious, Sembcorp Marine’s the one with the superior returns on equity over the timeframe we’re looking at.

Ability to generate free cash flow 

Free cash flow is an important number for investors to look at. It is the leftover cash brought in by a company’s operations after it has spent the necessary capital needed to maintain its businesses at their current state.

A company can then use the free cash flow to benefit its shareholders in a number of ways including the payment dividends, buying back shares, strengthening the balance sheet, and investing for growth.

Sembcorp Marine and Sapura Kencana - free cash flow (FCF)
Source: S&P Capital IQ (click chart for larger image)

It’d be a tie here – both Sembcorp Marine and Sapura Kencana have fared poorly in this category as they have not been able to generate free cash flow consistently over the past few years.

Balance sheet strength

The presence of high amounts of debt weakens a company’s financial health and adds risk for shareholders. That’s why it’s crucial for investors to pay attention to a company’s balance sheet.

Sembcorp Marine’s net-debt (total debt minus total cash) to equity ratio of 64% at the moment is clearly way healthier than Sapura Kencana’s 128%. But while Sembcorp Marine has the relatively stronger balance sheet here, the company’s actually akin to being the best block in a bad neighbourhood – a net debt to equity ratio of 64% is not a low number.

A Fool’s take

In a tally of the final scores, Sembcorp Marine, Singapore’s representative, is the ultimate winner as it had bested its Malaysian counterpart, Sapura Kencana, in three of the four categories.

Notably, what you’ve seen above shouldn’t be taken as the final word on the investing merits of the two companies. Instead, it serves as a useful starting point for further analysis.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.