Should you buy Premier Oil plc after today’s update?

Is Premier Oil plc (LON:PMO) a better buy than these two sector peers after today’s news?

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Premier Oil (LSE: PMO) has updated the market today on its financial standing that should help investors decide whether it’s worth buying, or if resources sector peers such as Shell (LSE: RDSB) and Lonmin (LSE: LMI) offer superior risk/reward opportunities.

The release from Premier Oil states that it continues in discussions with its lending group on the terms of its existing financial facilities. During these discussions, Premier has been receiving monthly deferrals in respect of the tests of its financial covenants.

Therefore, the test for the 12-month period ending 31 August has been waived, which was widely expected. It will now be replaced by a test for the 12-month period ending 30 September 2016 and Premier expects to receive monthly deferrals to the test of its financial covenants until negotiations are concluded.

The company says in the release that the discussions continue to progress well. Clearly, there’s no guarantee that there will be a positive outcome for Premier Oil, but its long-term future appears to be bright. That’s partly because of a rising oil price, but also because of the strategy the company is following. It has sought to take advantage of low asset prices across the resources industry through asset purchases.

Similar strategy

For example, Premier has bought Eon’s North Sea assets and this, alongside cost-cutting, should provide it with a clear path to growing profitability over the medium-to-long term. In this sense it’s somewhat similar to resources peer Lonmin, which was facing a challenging outlook. Lonmin was able to raise capital in order to progress with a strategy of streamlining its business. This is expected to bear fruit in the next financial year, when Lonmin is forecast to return to a black bottom line.

Furthermore, Lonmin’s growth prospects beyond next year are bright. It has a high quality asset base and its business model is becoming increasingly efficient. However, with it trading on a forward price-to-earnings (P/E) ratio of 78 versus a forward P/E ratio of 40 for Premier Oil, the latter has greater appeal at the present time.

More sure of Shell?

However, both Lonmin and Premier Oil are yet to return to profitability and the outlook for the resources sector can change quickly. Shell remains a highly profitable business with a much stronger balance sheet than these two peers. As such, it offers a far lower level of risk which, given the uncertainty that remains present in the commodity markets, is a major ally for investors.

In addition, Shell is forecast to grow its bottom line by 99% in the next financial year and this puts it on a forward P/E ratio of only 12.7. This indicates that there’s greater upward rerating potential when compared to Premier Oil and Lonmin, which makes Shell’s risk/reward ratio much more enticing than for either of its two resources peers. And with Shell having greater diversity and a more reliable asset base, its overall appeal for long-term investors remains very high.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens owns shares of Royal Dutch Shell. The Motley Fool UK has recommended Royal Dutch Shell B. 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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