About: Oil Search owns stakes in oil and gas fields. Its main asset is a 29% holding in PNG LNG, a liquefied natural gas project located in Papua New Guinea. The PNG government, Total and ExxonMobile are the other major shareholders in the project, which is being operated by the latter. In February 2018 Oil Search purchased oil fields in Alaska, which now represent its second most significant asset and an important growth prospect, although production is not slated to begin for several years.

Why it is in the portfolio: OSH’s main asset, PNG LNG, is considered to be a world-class gas asset, with large reserves and cheap production costs. It is already cash-flow positive for OSH, and contains options for reinvestment into expansion. Although at a much earlier development stage, the Alaskan oil fields appears promising, with potentially high reserves and ability to get the oil out of the ground at a reasonable cost using modern technologies. It appears the market is applying a discount to PNG LNG’s valuation, probably because of its location, its multiple shareholders (of which OSH is the least powerful) and potential for disagreement and disputes between them. On the other hand, these very same factors (and recent share price decline) make OSH an attractively priced Energy company with growth potential. Likewise, based on current share price the market is assigning a value of close to zero to OSH’s Alaskan asset, on the basis that production and profits are too uncertain at this stage. For current holders of OSH this means that the Alaska asset is almost a free option (i.e. upside potential with very little downside). OSH is held in the portfolio in conjunction with another Energy company (Woodside Petroleum), at a relatively low weight (3%) and in the wider context of a diversified portfolio, all of which serve to mitigate the risks cited here.

Fundamentals: Oil Search has a 1-year forward P/E of 15x, a 1-year forward gross dividend yield of 3.2% with a payout ratio of 48%. Its debt-to-assets ratio sits at 32% and it has a Price-to-Book ratio of 1.4x. OSH is trading at the bottom of its valuation range, with a forward P/E of 15 being 1 standard deviation away from its long-term average of 21.

What could go wrong: The primary risk with OSH is that the bulk of its revenue originates from one of the most lawless regions in Papua New Guinea, itself one of the most dangerous countries in the world. This presents risks to production itself, as well as to the project’s operating licence. When PNG’s Prime Minister was unexpectedly replaced recently, OSH share price dipped by close to 12%, reflecting these uncertainties.