Why I'd sell UK Oil & Gas Investments plc to buy IQE plc
Both stocks have surged higher recently. But what lies behind these latest gains?
This could be a 10 bagger
Cardiff-based IQE supplies "advanced wafer products and wafer services" for the semiconductor industry. This £865m firm looks expensive. The shares trade on 39 times 2017 forecast earnings, and offer no dividend yield.
On the face of it, this valuation certainly doesn't leave much room for error. But it's important to remember that this value is based on the company's historic profits and on expected growth rates for this year.
IQE reported sales of £132.7m and an after-tax profit of £19.4m in 2016. In July, the company advised investors that sales for the first half of this year are expected to be about £70m, while H1 profits should be in line with expectations.
The story behind the stock's rise is the potential for the firm's technology to win mass-market adoption.
In July, the firm advised investors that 2017 full-year profits were expected to "exceed market expectations." Chief executive Dr Drew Nelson said that if the company continues to win new contracts at the current rate, 2018 profits could be significantly above current forecasts.
The investment case for IQE obviously requires a hefty dose of optimism. But the firm is profitable and has a real commercial product. In my view, there's a good chance that investors could see further gains.
How much oil is there?
UK Oil & Gas Investment's 2016 drilling campaign in the Weald Basin, near Gatwick Airport, attracted a lot of media coverage. Estimated oil in place volumes of about 10bn barrels won headlines and sparked talk of a 'Gatwick gusher'.
The firm's 2016 Horse Hill-1 well flowed at an apparently impressive stabilised rate of 1,688 barrels of oil per day (bopd). Although it's worth noting that this rate was achieved for less than nine hours. No extended flow test was undertaken.
Investors are now waiting for the results from this year's Broadford Bridge-1 well. The company says that its interpretation of the drilling results so far suggest that "a significant continuous oil deposit" has been demonstrated by the Broadford Bridge drilling campaign.
Based on this data and last year's Horse Hill results, the firm's conclusion is that "this continuous oil deposit therefore likely underlies the entire PEDL234 licence."
It's worth noting that critics of this firm have pointed out that both the Horse Hill and Broadford Bridge wells appear to have been drilled close to faults in the rock -- isolated pockets likely to contain trapped oil.
Their analysis suggests that the drilling results so far may do nothing more than confirm what we already know, which is that the Weald Basin contains a lot of so-called tight oil. There's no guarantee that this will be commercially viable.
The conflicting interpretations of UK Oil & Gas's drilling results suggest to me that this is a very speculative stock. If the group's critics are proved right, the share price could crash.
I'm not in a position to judge what the eventual outcome will be, but at current levels I would certainly take profits and sell.
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Roland Head has no position in any shares mentioned. 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.