Investment Column: Melrose is not your average E&P, so buy

Henderson; New World Resources
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The Independent Online

Our view: Buy

Share price: 310.4p (+8.4p)

Investing in oil and gas explorers and producers can be tricky. Besides studying the company, investors must keep an eye on the commodity markets. Predicting a spike or slump in oil or gas prices is fraught with difficulty, and yet those movements colour the performance of resource-related stocks. One badly timed fluctuation could, at least in the short term, lead to a nasty loss.

That said, some E&Ps are less prone than others. Melrose Resources, the Edinburgh-based group which yesterday said that it had met its production expectations for 2009, is one such company. It benefits from fixed price contracts in Egypt, where the majority of its current production is located, thereby reducing its sensitivity to commodity prices. Beyond Egypt, the company said yesterday that it had signed a letter of intent with a Bulgarian gas trading operation to sell 4.24 billion cubic feet of gas from its Kavarna field in the first year of development. A proportion of the gas will be bought in advance, with $10.2m due before first production. As Numis points out, further gas sales contracts here could de-risk the commercial aspects of the company's activities. In Romania, Melrose said it was "cautiously optimistic" about winning government approval for the assignment of its interests in two offshore concessions within the next month or two, and is preparing to operate an exploration well in the third quarter of the year – a green light here could provide a short-term boost for the shares.

The stock trades at 0.76 times Numis's estimated net asset value. That is below the company's peer group of small and mid-cap E&Ps: an anomaly, in our view, in light of Melrose's relatively low commodity price sensitivity. They pay a dividend – a rarity in this sector. Besides Romania, analysts are awaiting news from Egypt, which could also help to drive performance. We think Melrose is one to watch. Buy.

Henderson

Our view: Buy

Share price: 122.1p (+2.5p)

Henderson has not had an easy time of it in recent years, although what fund manager has. Now that could be about to change. Yesterday's results were solid, with a pre-tax loss of £17m in 2008 turned into a profit of £15.5m in 2009. When various one-offs are stripped out, profit actually fell to £63m from £80m, but it is the future that makes Henderson look interesting.

With markets having recovered from the volatility of the credit crunch, retail investors are back. Don't be fooled by the net outflow of funds the business suffered. The money that departed was largely in low-margin areas such as cash or life insurance funds from Pearl, where the company anyway has a revenue guarantee.

A lot of the money coming in was from high net worth clients, hedge funds and various retail products, all of which offer decent margins. That money will keep flowing in if Henderson keeps up its impressive performance: 94 per cent of fixed income and 70 per cent of equity funds beat their benchmarks. This is being noticed, and the company has also benefited from a general move into equity-linked products by savers in the fourth quarter. For example, the high net worth business added £300m of funds in quarter three, but £1bn in the fourth. Trading on just 13.6 times forecast earnings, Henderson is not expensive, given its prospects. The dividend, to its credit, was also held through the crisis and should rise from here. Buy, with confidence.

New World Resources

Our view: Sell

Share price: 609p (+23p)

New World Resources is aptly named. The Central European hard coal producer only listed 18 months ago, and as the executive chairman, Mike Salamon, put it in yesterday's annual results, "2009 was a year of two halves".

For the first six months, sales of coking coal and coke both plummeted as the global downturn bit. The market for merchant coke was also decimated, and only thermal coal held stable. But the second half of the year saw considerable improvement, as steel production jumped by 45 per cent from April to December – taking coking coal and coke demand with it.

Taken together, the company's full-year results came in with revenues down 38 per cent to €1.1bn (£967m), and earnings before interest, taxation, deductions and amortisations down 74 per cent at €179m.

Mr Salamon says that the numbers – including operating costs slashed by 19 per cent – demonstrate NWR's resilience. But we are still concerned. The company claims its safety performance is improving. But there were still five fatalities in its mines in the last 12 months, one of them the day before the results were published. Add to that the fact that the share price has already roughly doubled since last summer, and New World Resources is a sell.

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