Shares in mid-cap oil explorers Enquest (LSE: ENQ), Premier Oil (LSE: PMO) and Tullow Oil (LSE: TLW) have racked up a staggering performance so far this year.
Indeed, in the year-to-date Enquest’s share price has risen by 61% — and that’s actually a drop back from the end of April, when they they were up around 120%. Shares in Tullow Oil are up by around 100% since the January lows, and shares in Premier Oil are up a staggering 270% since the January lows.
In comparison, in the year-to-date the FTSE 100 has lost 0.6%, the FTSE 250 has lost 3%, and the FTSE 350 is down by 1%. (All of these figures exclude dividends.)
So, Enquest, Premier, and Tullow have all dramatically outperformed the UK’s three main stock indexes so far this year. But can they repeat this performance?
The oil price is key
The future performance of these mid-cap oil explorers depends on where the price of oil goes over the next few months. Most City analysts now believe that the price of oil will stabilize at the $50 a barrel level for the rest of 2016, as oil production continues to contract while demand picks up.
This would be a huge boost to oil producers. Premier, Enquest and Tullow have all done an enormous amount to lower production costs over the past 24 months as the price of oil has slumped and these actions should now begin to pay off as oil prices stabilise.
Unfortunately, there is one issue that could hold these companies back, and that’s debt. All three explorers have a mountain of debt to service, which didn’t seem so bad when the price of oil was $100/bbl. However, in today’s $50/bbl world, this debt is a huge concern for investors. Indeed, the Sunday Times reported last week that Enquest and Premier are in talks with the UK Oil and Gas Authority about insolvency contingency plans.
Getting debt under control
Tullow’s net debt stands at $4bn, compared with the company’s current market cap of around $3.5bn, which leaves the company little room for manoeuvre. Still, management expects the group to generate positive free cash flow in the final quarter of 2016 when the company’s TEN project finally starts to generate a return. The company is aiming to start paying down its debt during 2017.
City analysts expect Tullow’s pre-tax profit to hit around £40m this year and £200m for 2017, although these forecasts are likely to be revised higher as oil prices rise. The company currently trades at a forward P/E of 178, falling to 25.4 next year.
Difficult to value
Both Tullow’s management and City analysts expect the company to return to profit this year, which makes it easier to value the company’s shares. But when it comes to Premier and Enquest, it’s harder to place a value these companies as they’re not expected to report a profit for the next two years.
Specifically, the City is expecting Premier to report a pre-tax loss of £104m and £21m for 2016 and 2017, respectively. Enquest is projected to report a pre-tax loss of £18m for 2016 and a larger loss of £36m for 2017. With such massive losses expected and rumours of insolvency, it’s hard to believe that these companies can repeat their year-to-date gains.
