Are GOIL Shares Running Out of Gas?

The past year has been a great time for Ghana Oil (GOIL) shareholders. The stock has roared 260% higher over the past twelve months, but high valuation multiples should give investors pause.

The past year has been a very good time to own Ghana Oil (GOIL) shares.

The stock has roared 260% higher over the past twelve months, propelled by high-octane earnings growth and a cheery outlook for the Ghanaian economy.

Today, the shares change hands at a price of GHS4.05 per stub, which gives the stock a price-t0-earnings ratio of 24.3. That’s a lofty level, and as I will argue below, I think it’s an indication that shareholders should begin looking for an exit ramp.

But first a bit of background.

High-octane Growth

Majority-owned by the Ghanaian government, GOIL is Ghana’s leading marketer of gasoline and oil products. It operates 330 filling stations across the country and also distributes aviation fuel, bunker fuel for ships, lubricants, and LPG. All told, the company controls 18% of the nation’s oil products market – up from 13% five years ago.

GOIL’s earnings per share have more than tripled over the past four years. This impressive growth was fueled in part by the cost of a barrel of crude dropping from triple digits to its current level of $61.98.

Low oil prices make it easier for oil marketers to purchase, store, and sell their inventory, which translates into increased revenue and profitability. GOIL has grown its gross profit at a 36% rate since the end of 2012. And while just 22% of gross profit trickled down to the company’s bottom line five years ago, today GOIL pockets 32%.

The company has also benefited from the intensifying hunt for oil off Ghana’s shores. Exploration companies need a reliable source of fuel for their ships and helicopters and GOIL successfully scored several plum supply contracts.

In mid-2016, the company came back to the market to via a GHS155.0 million rights issue and used the proceeds to pay down debt, fund expansion and renovation of its fillings stations, and to invest in new facilities like a just completed fueling terminal for ocean-going ships and a bitumen plant intended to supply road construction contractors.

GOIL reported strong 22% earnings growth for 2017 on the back of a 16% increase in gross profit. It also eliminated its long-term debt load. The news has been well-received by investors, who have sent the share price 6% higher since the results were announced two weeks ago.

Free cash flow remained in negative territory for the fourth consecutive year. This stands to reason given GOIL’s heavy capital expenditure over the past few years. But it raises the question whether the new assets will be able to sustain earnings growth at a sufficiently rapid rate to avoid a selloff in the stock. And the dwindling cash balance raises the specter of another dilutive rights offer.

GOIL: Buy, Sell, or Hold?

So, is the stock a buy, sell, or hold?

GOIL shares are currently priced at a price-to-earnings ratio of 24.3 and a price to book ratio of 4.2. That’s the high water mark for both metrics since the conclusion of the 2016 rights offer.

Because earnings can be volatile and are relatively easy to manipulate, I prefer to use book value per share (NAV/share) as the basis of my valuation models whenever reasonable.

So, to determine whether GOIL shares are currently a bargain or a ripoff, we need to make some assumptions about how quickly the company’s book value per share will grow and how dearly the market will value this equity at a certain point in the future.

Over the past five years, GOIL’s NAV/share has grown at a scorching 38.5% annualized rate. It would be foolish for us to assume that this rate can be sustained over the next five years – the number is just too big. So, let’s assume it moderates to 25% between now and the end of 2022. That’s still an exceedingly rapid rate of growth for an oil marketing company, and it outpaces the 21% increase in NAV/share that GOIL posted over the past twelve months.

If this assumption is accurate, GOIL’s net asset value will stand at GHS2.90 per share in February 2023.

Now, let’s take a stab at what kind of premium investors might be willing to pay for GHS2.90 worth of GOIL equity in February 2023.

In the year and a half since GOIL’s rights offer, the stock has traded at a price-book ratio as high as 4.2 (today) and as low as 1.3 (in December 2016). The average month-end price-book ratio during this period was 2.3.

I believe there’s a very good chance we will see the stock hover around this mean over the next five years.

If we apply a 2.3 book multiple to an NAV/share forecast of GHS2.90, we get an estimated Feb 2023 share price of GHS6.67.

Add in a few pesewas for dividends and we’re left with an annualized return of 11.3%.

That might sound like a decent return, but keep in mind that Ghana’s inflation rate presently stands at 11.8%. Thus, there’s a risk of the stock posting a loss in real terms over the next five years – especially considering that we used a rather optimistic NAV growth assumption.

So, it’s been a fantastic ride for GOIL shareholders, but I’m thinking it’s time to look for the brake pedal. The stock is a sell at its current price.

Disclosure: At time of publication I owned shares of Ghana Oil.

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