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Time to get greedy with Premier Oil plc and Petra Diamonds Limited?

Shares of Petra Diamonds (LSE: PDL) are little changed today at 82p after the company reported a “strong start” to its new financial year and maintained full-year production guidance of between 4.8 and 5m carats.

Petra’s Q1 performance was affected by labour disputes at three of its four South African mines during September (since resolved by new three-year wage agreements) and by a government export block on a parcel of 71,654 carats from its Tanzania mine. It’s since received authorisation to resume exports, although a resolution has not yet been reached on the parcel of 71,654 carats.

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These are the sorts of issues that come and go from time to time and I’m far more interested in the broader outlook for the company.

Rapid growth ahead

Petra has been investing heavily over the past few years, with expansion capex reaching $275m in fiscal 2016 and $230m in the latest financial year ended 30 June. Production in the new mining areas will be mostly from undiluted ore and management expects this to be a major contributor in expanding the group’s operating margin from last year’s 33% to between 45% and 50% by fiscal 2019.

Petra today reported net debt of $614m (£465m at current exchange rates), which is higher than its market cap of £436m. Furthermore, due to the labour dispute in South Africa and uncertainty about the final sales volume out of Tanzania ahead of 30 December, the company is at risk of breaching EBITDA-related debt covenant tests at that date. However, I fully expect lenders to remain supportive. That’s because of the particular circumstances and the fact that Petra is set to become free-cashflow-positive in calendar 2018 as capex declines significantly after the period of heavy investment in expansion.

The City is forecasting rapid growth in earnings per share (EPS) over the next few years: 14 cents (10.6p) for the current year, followed by 20 cents (15.15p) and 26 cents (19.7p). This gives price-to-earnings (P/E) ratios of 7.7, 5.4 and 4.2. I believe the market is over-pessimistic about Petra’s debt burden and I rate the stock a ‘buy’ on the basis that, while it’s undeniably higher risk, the rewards could be substantial from the current share price level.

Much improved outlook

Premier Oil (LSE: PMO) is another company whose level of debt has weighed heavily on market sentiment. At a share price of 64p, its market cap is £329m, while last reported net debt was $2.7bn (£2.1bn).

However, Premier’s lenders have remained supportive, net debt is already falling, as the company has become free-cashflow-positive. Furthermore, deleveraging is set to accelerate as its Catcher field comes on-stream. In an update today, the company confirmed that delivery of first oil remains on schedule by the end of the year.

City analysts are forecasting a big jump in EPS in 2018 to 21 cents (15.9p), followed by 30 cents (22.7p) for 2019. This gives P/Es of four and 2.8. Again, I believe the rewards could be substantial from the current share price level and I rate the stock a ‘buy’ at the higher-risk end of the investing spectrum.

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G A Chester 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.