Many investors were caught by surprise when Afren (LSE: AFR) admitted it might need to raise £200m from investors earlier this week — but the Nigeria-focused firm is unlikely to be the last casualty of low oil prices.
Enquest shares soared last week after the firm announced that its lenders had agreed to relax the terms of Enquest’s debt until mid-2017.
This may be a short-term lifeline for Enquest, which has net debt of $1bn, but the fact it was necessary suggests it won’t be enough to solve the problems the firm will face if oil prices stay low.
Bond investors seem to agree — according to Bloomberg data, the yield on Enquest bonds has risen from 5% in July 2014 to around 13% today.
The problem is that Enquest isn’t generating enough cash to fund its capital expenditure, let alone repay any of its debt. Enquest’s numbers suggest to me that despite making cuts, it will have to draw down significant amounts more debt during the coming year, in order to fund its planned expenditure of $600m.
This could leave Enquest unable to service its debt unless oil prices recover strongly — a big risk.
Premier is a larger firm than Enquest, and should be in a stronger financial situation, in my view, but there are some similarities.
Premier spent $1bn on capital expenditure in 2014, and plans to spend $600m in 2015. Based on the firm’s most recent reported figures, I estimate that the firm’s operating cash flow from last year will be around $1bn, including one-off gains from asset sales of $147m.
Net debt is currently $2.1bn, with cash and undrawn facilities of $1.9bn.
Although a significant portion of Premier’s sales are gas, the firm has only hedged around 40% of its oil output for 2015. In my view this means that the firm is likely to have to draw down more of it debt to fund its operations and capex, creating a hefty repayment burden for future years — and putting the firm’s dividend at risk.
Premier vs Enquest
I think Enquest is at greater risk of Afren-style financial problems than Premier, but I’m not comfortable with either firm’s position, as both are already heavily indebted and likely to become more so this year.
In my view, there are better buys elsewhere in the oil market.
Indeed, if you're aiming to make big profits from resource shares, I'd strongly suggest you take a look at "10 Steps To Making A Million In The Markets".
This exclusive FREE report carries no obligation and includes details of a simple 10-step strategy that could help you build a portfolio with the potential to hammer the wider market.
To find out more, download your free Millionaire Report today -- just click here now to get started.
Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Afren. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.