Is Falcon Energy Group Cheap?

Previously, I wrote about how the Price-Book (P/B) ratio could be viewed in tandem with Return on Asset (ROA) or Return on Equity (ROE) to help identify value.

Based on these two simple metrics, we could, for instance, filter companies in the energy industry that could be considered “cheap”. Supposed we assume that at a P/B of less than 1.0, the ROE should be at least 10% to be worthy of consideration.

A quick filter highlights a few companies that fall within our criteria.

FalconFilterSource: S&P Capital IQ

There are seven companies that pass muster from the Energy Sector. Of the seven, all are from Energy Equipment and Services sector, as they tend to react slower to falling oil prices. Direct Oil and Gas industry players could be some of the first to be impacted.

Let us start by taking a look at the company that provides the highest dividend yield, namely, Falcon Energy Group (SGX: 5FL). With last year’s dividend payout of $0.015, Falcon Energy yields around 7%, which can be considered attractive, given today’s low interest rates.

So, is the company cheap?

Falcon Energy trades at a P/B ratio of 0.38. It has delivered a Return on Equity of 19% for past the 12 months. Based on the basic ratio, it looks like a dream stock with a low P/B, paired with high ROE and high dividend yield. Or so it might seem.

However, brokers at Macquarie reckon that a structural decline in the oil and gas sector could put around 70% of SembCorp Marine’s (SGX: S51) and Keppel Corporation’s (SGX: BN4) US$8b order book at a high risk of cancellation. By inference, we might assume that other energy equipment linked companies could suffer a similar decline in earnings over the next few years too. In fact, income at these companies has always been highly volatile.

falcon net income

Past data shows that Falcon Energy’s income has fluctuated wildly, which even led to a loss in 2013. Recent years have been some of the best for the company. But these are unlikely to be repeated with the current oil prices.

To make matters worse, Falcon Energy’s Return on Assets is a measly 1.56%, with a high debt-to-equity ratio of 1.25. That could suggest a rise in interest rates might hurt the company.

Can the company then still maintain its dividend yield of 7%? Let’s take a look at how much it has paid out over the past few years.

falcon dividends

Before 2008, Falcon Energy did not pay a dividend. In 2015, over 75% its revenues were derived from Oilfield and Drilling Services. Additionally, China accounted for over 60% of its sales. Consequently, when major oil companies scale back on production, and coupled with China’s slowdown, Falcon Energy’s income could be badly hit.

falcon segments

Should income dwindle over the next few years, investors should expect dividends to dwindle as well.

Amidst all the chaos in the Oil and Gas industry, there are still some merits to Falcon Energy. These include a heavily discounted valuation and over 30 years of experience in the industry.

The company remains one of the leading players in the region, with major contracts with Royal Dutch Shell, Exxon and PetroChina. A shakeout in the industry could, in fact, present new opportunities for the company, if it is able to seize them.

Historical numbers and valuations can be deceiving, if not put into perspective with the underlying business and the industry. Ratios can only provide a good start to understanding a company. It shouldn’t be used as the only point of consideration, when investing in any business.

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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 contributor, Wilson Ong, doesn’t own shares in any companies mentioned.