Why I’d sell Premier Oil shares today

PMO shares may look cheap after recent declines. But the company is drowning in debt and facing years of low oil prices, which may hamper its recovery.

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The last time I covered Premier Oil (LSE: PMO) shares, I concluded that while it looks as if the company will be able to survive in the near term, its long-term outlook is more uncertain.

Since then, it’s become clear the company is facing a vastly different operating environment. As a result, the group’s outlook seems to have deteriorated significantly. And so have the prospects for PMO shares.

PMO shares slide

At the beginning of the year, the price of oil was trading at around $60 per barrel. But since then, the oil market has been thrown into turmoil by the coronavirus crisis. At one point at the end of May, the price of oil had dropped below $20 a barrel.

The price of the black gold has since recovered above $40. However, at this stage, it’s difficult to tell if it will ever return to previous highs.

Oil demand is expected to fall around the world this year. Big oil and gas companies have already started writing down the value of their assets. Billions of pounds of assets have been written off to reflect this new normal. This could be a big problem for PMO shares. The company entered the crisis with one of the weakest balance sheets in the sector.

Weak balance sheet

At the last trading update, Premier reported a net debt position of $1.99bn and a half-year cash position of $254m. It’s also in the process of spending around £475m buying some North Sea assets from BP.

The firm has managed to renegotiate the terms of this deal. The value of the cash payable upon completion is falling and other payments are being deferred. Nevertheless, it’s still a significant outlay for such an indebted business.

To fund the deal, and help improve the state of its balance sheet, analysts reckon PMO is planning to raise funds from shareholders. A figure of £200m has been touted. The firm’s current market capitalisation is only £460m.

As such, a cash raise of this size would significantly dilute existing investors and could send PMO shares plunging. However, if the group wants to improve the strength of its balance sheet, management may have no choice.

The risk of this dilution taking place suggests it could be sensible for investors to avoid PMO shares for the time being.

High risk, high reward

Having said all of the above, PMO shares could still yield high total returns for investors if oil prices recover, although that’s a big ‘if’ considering the current state of the world economy.

If you do believe in the company’s prospects, it may be best to own PMO shares as part of a well-diversified portfolio. Doing so would allow you to benefit from any upside potential while minimising downside risk if the business falls into bankruptcy, or has to ask shareholders for additional funds.

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.

Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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