Shares in small-cap oil explorer Premier Oil (LSE: PMO) declined 2.5% last month even though the company reported a positive set of half-year results at the end of August.
For the six months to the end of June 2019, Premier’s pre-tax profit jumped to $121m, from $98m in 2018. Production surged to 84.1 thousand barrels of oil equivalent per day (kboepd), a record for the business.
More importantly, the company’s net debt fell from $2.33bn at the end of 2018, to $2.15bn at the end of June.
This reduction in borrowing is particularly important. Premier has been struggling to get its borrowing under control for the past few years. At one point, there was a genuine chance that the business could collapse under the weight of its debt.
Look to the fundamentals
It seems to me that rather than concentrating on these positive developments, the market focused on the volatile oil price last month.
However, the fact that borrowing is now falling tells me Premier has put the worst behind it. The group generated free cash flow of $182m during the first half of 2019, and if it can repeat this during the second half, net debt will fall below $2bn.
Management has stated that the company is on track to reduce net debt by $300m with free cash flow alone this year. It looks as if the business is well on the way to meeting that target.
Rising earnings
The more debt Premier can pay down, the better the firm’s prospects will become. In the first six months of 2019, the company forked out a total of $219m in interest costs and other finance expenses.
In comparison, pre-tax profit from operations was just $120m. To put it another way, these figures suggest that if Premier can halve its debt pile, pre-tax profit could double, assuming everything else remains unchanged.
It will take a few years for Premier’s net debt to fall to $1bn with the company paying off $300m per year, but at least the business is heading in the right direction.
Further progress on debt reduction in the second half of this year and in 2020 will, in my opinion, only make the company more attractive as an investment. What’s more, as its balance sheet becomes stronger management can afford to reinvest more money back into operations to drive growth.
Based on current City estimates, shares in Premier are currently dealing at a forward price-to-earnings of just 9.4. With earnings per share projected to jump by 34% in 2020, the stock is only going to get cheaper over the next few months, according to the City’s projections. Based on these numbers the stock is trading at a 2020 P/E of 7.
The bottom line
So overall, the Premier share price lost 2.5% in September, but after considering the company’s progress improving production and reducing debt, I think the market is spending too much time focusing on the volatile oil price and not enough time considering the stock’s improving underlying fundamentals.
For that reason, I think this might be an attractive investment for risk-tolerant investors.
