Investor's Champion Blog
Provides refreshingly forthright, independent comment on predominantly small cap companies and specialist investment funds. Informed opinion, based on first-hand research, but pulls no punches in exposing management weaknesses.

Sovereign Oilfield Group-could it be a ten bagger?

I met with the management of Sovereign Oilfield Group today to discuss their interim results to 30th September 2006.

Sovereign was formed in October 2003 and floated on AIM in September 2005.
With its head office in Aberdeen the group’s strategy is to ‘build a large integrated international oilfield services group’ split between fabrication and drilling services.

Since coming to AIM it has made 3 acquisitions, one of which, the conveniently named ‘OIL’, has dramatically, altered the top line. The group now comprises 7 distinct operating entities.

Turnover for the 6 months ended 30th September was £23m and the net profit (after the exceptional items and goodwill amortisation) was £0.4m.

Whilst the interim results demonstrated strong top-line growth with a higher than expected rise in central costs and disappointing performance from one of the divisions the house broker reduced their full year pre-tax profit forecasts from £2.7m to £2.5m and lowered their recommendation from Buy to Hold-whatever that means!

The shares floated at price of 140p, have been as high as 250p but currently stand at 210p, some 50% above the float price which results in a market cap of c£34.5m.

I like Sovereign but as a classic roll up vehicle that is regularly making acquisitions it is very hard to make accurate comparisons between one period and the next.

With the oil price at current levels market conditions are obviously in its favour and some of the operating businesses in the group appear to be doing very nicely. Others, notably those located in France and Belgium (typical!), appear to have caused a few headaches but are apparently on the road to recovery.

Perhaps of greatest concern to me are the increasing working capital demands on the expanding business and increasingly diverse business. With net debt at £6.1m at the interim stage and banking facilities of c$8m there isn’t much room for manoeuvre if they want to fulfil their ambitions of establishing an operation in Abu Dhabi and support all the other projects. In the short term future acquisitions are likely to be debt funded which should also result in some interesting negotiations with the banks-which are harder to convince than willing shareholders!

It’s a tough job for a small operation such as Sovereign to manage the demands of the City, acquisitions and restructuring but management appears to have a handle on things having standardised the financial reporting function across the group and put in new management at poorly performing operations.

I would like to see period of consolidation but am obviously unlikely to see this with further acquisitions on the cards.

There appears to be great potential in several of the businesses I just hope they can effectively manage working capital demands. If some of the hitherto poor performers start to come good they should easily meet 2008 house broker’s forecasts, which is really what investors should be looking for in a high risk, small cap, roll up vehicle such as this. With the likelihood of further acquisitions the current forecasts will probably be rendered meaningless by the end of 2007 or sooner!

I remain a little concerned that they are biting off more than they can chew in the case of the proposed Abu Dhabi expansion which could also start to tie up a lot of cash and resource. You can be assured that the City won’t be very patient if things take a lot longer than anticipated.
However, to repeat, I think this is what investors should be looking for; otherwise surely it would be better to play the CFD in one of the bigger quoted oil service groups.

As usual it would be nice for other ‘independents’ to pick up coverage on the stock. I’m sure that Graham Burgess the Chief Exec would be more than happy to communicate the story.


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