Since mid-2014, shares in Premier Oil (LSE: PMO) have floundered. Falling oil prices have weighed heavily on the group, and capital spending obligations have drained the company’s coffers, pushing up debt.
Writedowns on the value of its oil-producing properties, as well as high costs and negative margins, have pushed the company into a loss for the past three years. In fact, since 2014 the group has reported a total pre-tax loss of $1.5bn, more than twice its current market cap.
However, in the past few weeks, Premier’s outlook has changed completely. At the end of December, the firm reported that it had produced first oil from its flagship Catcher project in the North Sea — the project that has been responsible for the majority of the group’s issues these last few years.
From cash drain to cash cow
Premier started the development of Catcher in 2014, just before oil prices collapsed leaving it committed to a high-cost project at the wrong point in the cycle.
Funding the $1.6bn projected pushed net debt to $2.8bn at the end of September. Nonetheless, now that oil is flowing, the company should be able to start paying off these obligations. The development is expected produce about 10,000 barrels of oil per day, initially before ramping up to 60,000 bbl/d in the first half of 2018. Premier’s 50% ownership means its production will rise by 30,000 bbl/d as the project ramps up.
City analysts currently expect this production to yield a pre-tax profit of £140m for 2018, which translates into earnings per share of 14.7p, a forward P/E of 7.7 at current prices. What I’m interested in, however, is the company’s cash flow.
Debt reduction
The most significant cloud overhanging Premier right now is its debt. The firm has already negotiated its debt with creditors once, and before it can be taken seriously again, management needs to get the group back on a stable financial footing.
City estimates vary, but it is forecast that Premier could generate several hundred million dollars in cash flow from operations next year. Of course, this depends on what the price of oil does, but still, it is clear that the firm will be able to begin paying down its debt in 2018.
As the risk of bankruptcy fads, I see no reason why the shares cannot attract a higher earnings multiple.
Peers such as Genel Energy, Cairn Energy, Tullow Oil and BP Plc all trade at forward earnings multiples of 20 or more. On this basis, as Premier pays down debt, I see no reason why the shares can’t return to a sector average P/E of 20 or more. Based on current earnings forecasts, this implies a share price of 294p for the firm, up 250% from current levels. Moreover, as oil prices continue to push higher, I wouldn’t rule out further earnings upgrades, which could lead to gains of 300%.
