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Is the Harbour Energy share price a value trap?

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The Harbour Energy (LSE: HBR) share price has fallen 61% over the past 12 months. After this decline, the stock looks cheap. However, just because a stock looks cheap compared to its trading history doesn’t necessarily mean it is.

The company, which was formed in March with the merger of Chrysaor Holdings Ltd and Premier Oil plc, has a lot of debt. So even though the price of oil has recovered over the past few months, the firm’s financial position is still precarious. 

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As such, it’s not unreasonable to say the business is worth considerably less today than it was at the beginning of last year.

But, as noted above, the price of oil has risen over the past few months. This should help the company’s recovery. And as the firm starts to recover, the Harbour Energy share price could follow suit.

The price of oil

The price of oil has roughly doubled in value since the middle of June last year. In fact, at $75 per barrel at the time of writing, the price of Brent crude is higher today than it was for the majority of 2019.

So, not only has the price of the commodity recovered all of its coronavirus losses, it’s moved back to levels not seen since 2018. 

For investments like the Harbour Energy share price, this is fantastic news. Oil producers have been struggling with low oil prices for years. As a result, many have taken drastic action to improve profit margins, including slashing operating and production costs to the bone. 

Harbour is no exception. According to the company’s latest trading update, it expects operating costs for the current financial year to be around $15-$16 per barrel. 

Lower costs and higher oil prices have helped the group reduce borrowing. Net debt at the end of May was $2.7bn, compared to $2.9bn at the end of March. 

Management also believes production across the group will increase throughout the remainder of 2021. This suggests the company could see increased profitability, cash flow and debt reduction in the months ahead.

Harbour Energy share price risks

The company’s latest trading update is incredibly encouraging. It shows management’s actions to reduce costs and increase output, primarily due to the merger between Chrysaor and Premier, are having a positive impact. 

That said, the company still has a lot of debt, which could take years to clear. What’s more, while the business does have a hedging programme in place, its sales and profits are still highly dependent on that oil price. 

Further, the company has poor Environmental, Social, and Governance credentials, which could make it unsuitable for some investors

A value trap can be broadly defined as any business that’s cheap for a reason. That’s usually because its ability to make profits has been severely and/or permanently impaired.

It seems to me that the Harbour Energy share price looks cheap because of the risks outlined above. However, its ability to make profits hasn’t been severely or permanently impaired, as evidenced by its recent cash generation and debt reduction. 

Therefore, I don’t think this is a value trap and I’d be happy to buy the stock for my portfolio as a recovery play. 

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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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