The Investment Column: High-risk projects mean that it is time to sell out of Tullow Oil

Insulation supplier SIG offers energy efficient growth; Islamic Bank of Britain is too rich for now
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The Independent Online

The Anglo-Irish Tullow was set up in 1985 and was overwhelmingly focused on gas production in the North Sea until last year, when it doubled in size with the acquisition of Energy Africa, bringing it a portfolio of producing assets and exploration prospects in West Africa.

We tipped the stock at 106.5p in 2002 and again at 136.5p last year, and yesterday's results were stonking thanks to a combination of high oil and gas prices and improved production levels. The company produced an average of 57,350 barrels of oil or equivalent every day in the first half of the year and, with reserves estimated at 338 million barrels, is confident of getting that up to 70,000 per day by the end of 2007.

Yet we think it is time to sell out of Tullow.

It is a contrarian view, and a risky one. Even the analyst at Oriel Securities, a lone bear of the stock, recently changed his view to neutral. Oil prices will stay high, and some calculations of Tullow's asset value still factor in too low a price for its output. But we think these factors are broadly reflected by the stock market value of the shares, well above most asset calculations, and the medium-term downside risk is significant.

Why? Firstly, the market is too optimistic about the results of high-risk drilling projects in Mauritania and Uganda later this year. Second, the high oil price has obscured rising costs across the natural resources sector, both in terms of materials used in rigs and the wages of skilled personnel. And third, Tullow's North Sea acquisitions this year have magnified its bet on UK gas prices, which may not stay as high as the company expects. Although the country is now a net importer, several projects to set up terminals for the importation of liquefied gas will come on line in the next few years, suggesting that future demand will be well met. Sell.

Insulation supplier SIG offers energy efficient growth

If we are entering a period of sustained high fuel prices, then we will want to adapt our behaviour in many ways. The Government has been legislating to improve energy efficiency for years, but with an economic incentive, too, one change could be more insulation for our houses. That at least is a theory put forward by David Williams, chief executive of SIG, which supplies specialist building materials including insulation, roofing, and commercial interiors from depots across the UK, Ireland and Continental Europe.

Things are going extraordinarily well for SIG at the moment. The introduction of the latest round of tighter building regulations in 2002 spurred a jump in sales of its insulation products that is only now levelling off. There will be another round by 2007.

At the same time, the UK economy has been very strong, with commercial and governmental building works ensuring high demand for interiors. SIG has also been winning market share on the Continent.

And the building supplies manufacturers, SIG's own suppliers, put up prices sharply last year, which distributors were able to pass on, enjoying an improved mark-up as a result. With energy costs likely to be used as a reason to put up prices again next year, this little inflationary spiral could be very beneficial between now and the new insulation regulations.

SIG operates in a consolidating industry, so there is further upside from acquisitions that boost earnings, or even from a takeover battle for SIG itself. Its shares still look fairly valued on 14 times earnings. Buy.

Islamic Bank of Britain is too rich for now

The Islamic Bank of Britain was one of the most interesting flotations of last year.

The company is introducing to Britain the concept of Sharia-compliant banking. IBB hopes that a significant proportion of Britain's 1.8 million Muslims will want to switch to its products, which swap the outlawed concept interest for an approved form of "profit share" for savers.

So far, the company has opened five branches, but it is a little behind schedule in the services it has rolled out. Current and savings accounts are available, but consumer finance products are being delayed by a wrangle over tax treatment. Online banking will only be in the testing phase by the end of the year. And IBB is yet to come up with a credit card that could pass its panel of Sharia advisers.

In these circumstances, the shares shouldn't be 33.5p, valuing the start-up at £140m, a 34 per cent premium to its float valuation.

With powerful backers from the Middle East and a marketing campaign that is trying to get imams on-side, IBB will turn into a profitable - and important - bank, but its valuation at this stage is too rich. Avoid.

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