Smaller Companies: Not much fire in this Dragon

SMALL oil companies in exploration and production are always attractive to the more adventurous investor, writes Richard Phillips.

Dragon Oil, the Irish explorer with reserves in the Caspian Sea, is a convincing example of this. Three years ago, it was a minnow and the shares traded at 40p. They fell to 25p, before more than doubling in 1997 to a high of 90p on the announcement of its Caspian ventures. The shares are now 71p. So it is a field where the scope of investors to get rich quick is more than evident. Conversely, it is a tried and tested route to losing your shirt.

A recent boost for Dragon came with the appointment of Dresdner Kleinwort Benson as financial adviser. DKB has also issued an analysis saying the shares are undervalued, and are worth closer to a pound. Even at 71p the company is valued at almost pounds 250m.

Yet - and here's the rub - Dragon only paid pounds 17.5m to buy its 25 per cent stake in Block II in offshore Turkmenistan. Can Dragon have found a field which, when it is exposed to the glare of public examination, is found to be undervalued by a whopping factor of 10 or more?

DKB has also pointed out that a realistic asset valuation translates to 63p a share. Other oil stocks, it says, stand at a 25 per cent premium. Perhaps, but there are identifiable problems with the Turkmenistan field. There are difficulties getting the oil out, and there is also the risk of bureaucracy hampering the project.

Finally, the Asian crisis may be a factor. The company's largest shareholder is Indonesian, and there may be share sales from this source over the next year. Dragon also has exploration acreage in Thailand, where 200 billion cubic foot of gas has been identified.

Over the years, with its prize Caspian asset, Dragon should see production rates, cash flow and possibly reserves all grow strongly. Cashflow per share, for example, could reach pounds 64.3m by the year 2000. It looks to be a well managed concern, which has rewarded its backers. But, despite the convincing upside in the years ahead, the shares more than look up with recent events. A weak hold at best.

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