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Is Premier Oil plc a better buy than BP plc?

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A number of oil stocks have performed exceptionally well since the start of the year. Among them is Premier Oil (LSE: PMO) with the North Sea-focused oil producer recording a share price rise of 55% year-to-date. This has been a much better performance than sector peer BP (LSE: BP), which is up by 26% over the same period.

This level of outperformance may lead some investors to determine that Premier Oil is a better buy than BP. After all, it has a sound strategy that should deliver a return to profitability over the medium term as well as rising profitability in the long run. Notably, Premier Oil has sought to reduce its cost base and improve efficiencies to successfully adapt to the extremely difficult operating environment oil companies face.

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It has also purchased Eon’s North Sea assets, which shows that Premier is planning for a higher long-term oil price and may be able to improve its outlook through the purchase of high quality assets at discounted prices.

Dividend questions

However, BP has also been busy adapting its business to a lower oil price environment. It has sought to reduce costs and become more efficient, but has continued to prioritise its dividend despite profitability coming under severe pressure. This has led many investors to question whether BP can afford its current dividend, or if a cut is on the cards.

While in the current year BP’s dividends aren’t set to be covered by profit, next year they’re expected to be. This bodes well for future shareholder payouts and due to BP having a yield of 6.2%, versus zero for Premier Oil, the former is clearly the more favourable selection for income-seeking investors.

Even though BP has been forced to rationalise its asset base in recent years, it’s still an oil major and that asset base is world class and highly diversified. In this sense, it offers lower risk than Premier Oil, which is much smaller and less diversified. As mentioned, Premier is unprofitable and forecast to remain so in the current year and the next financial year. BP, meanwhile, is highly profitable and expected to increase earnings by over 100% next year.

Stability and challenges

At a time when the price of oil could come under pressure, BP’s more stable and upbeat near-term outlook could be of greater appeal to most investors than Premier Oil’s rather challenging prospects.

Despite Premier’s risks, its price-to-book (P/B) ratio of 0.7 indicates that it remains a star buy. It has a wide margin of safety, a sound strategy and an asset base which, given an upbeat outlook for the oil price, should deliver an improving financial outlook. However, BP’s high profitability coupled with its exceptional growth forecast for next year, its diverse asset base and excellent dividend prospects make it the preferred option for long-term investors for now.

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We think it has the potential to become the next famous tech success story.

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Peter Stephens owns shares of BP. The Motley Fool UK has recommended BP. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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