Why I'd dump this FTSE 100 stock to buy Hurricane Energy plc

The Motley Fool
Oil rig with vessel
Oil rig with vessel

An update from North Sea oil explorer Hurricane Energy (LSE: HUR) reminded me of what a monster success this stock could become.

The company has confirmed that it's going to proceed with the early production development of its flagship Lancaster field, which contains 523m barrels of proven and probable reserves and resources.

First oil is expected in 2019 and production is expected to reach 17,000 barrels per day. The group has contracted a rig to complete the production wells and a floating production, storage and offloading (FPSO) vessel to operate the field.

Hurricane had a very successful drilling season last year, with two major discoveries, Halifax and Lincoln, in addition to progress with Lancaster. However, shareholders seem to have lost faith in the firm. After hitting a high of 68p in May, the shares have fallen by 55% to just 27p.

What's gone wrong?

One reason for the drop is that the group raised $530m through a share placing and convertible bond offering earlier this year. The money will be used to fund the development of Lancaster through to production, but obviously it has resulted in some dilution for shareholders.

I suspect some investors were hoping the firm would cash in quickly with a trade sale, rather than focusing on long-term development.

A second reason for Hurricane's slide may simply be that sentiment towards oil stocks has weakened generally, as doubts have grown about how quickly the price of oil will recover.

In my view, these risks are being overstated. With a market cap of £529m, Hurricane looks cheap to me relative to its resource base. In addition to the 523m barrels associated with Lancaster, the firm has a number of other assets with significant potential.

Although investors may need to be patient, I believe the shares could easily double from current levels. That's why I'd consider selling a slice of FTSE 100 commodities giant Glencore (LSE: GLEN) to fund an investment in Hurricane Energy.

Why choose Glencore?

Shares of the Switzerland-based commodity group have doubled in value over the last year. But I'm starting to feel that most of the good news may be in the price. One reason for this is that founder Ivan Glasenberg appears to be back on the acquisition trail.

Mr Glasenberg's willingness to load up with debt nearly landed him in trouble during the mining crash. He's turned things around admirably, but I'm unsure of how much value is on offer to new buyers.

Although Glencore's trading business generates a lot of cash, its success seems to require the group to own an ever-increasing range of mines and other producing assets. This year has already seen major investments in coal, copper and cobalt. Yet the firm's return on capital employed has averaged -0.7% since 2011, well below most FTSE 100 peers.

At this stage, I'm more attracted to big mining groups such as Rio Tinto and BHP Billiton, which are focusing more heavily on maximising the value from existing assets and on shareholder returns.

Glencore shares currently trade on a forecast P/E of 15, with a prospective yield of 2.4%. A dividend hike is pencilled in for 2018, but earnings are expected to be flat next year. In my view now could be a good time to take some money off the table.

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Roland Head owns shares of Rio Tinto. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.