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Why I’m not buying shares in Premier Oil plc just yet

Over the past four months, the price of oil has made an impressive recovery. After hitting a low of around $44 a barrel at the end of June, rising demand coupled with limited supply has pushed prices back above $60/bbl for the first time since early 2016. 

With oil prices rising, shares of oil producers have rallied. For example, shares in Premier Oil (LSE: PMO) are up 65% since the July low. However, despite this rise, I’m not buying the shares just yet. 

Uncertain outlook 

2017 has been something of a transformational year for Premier Oil. After several years of uncertainty, the company looks as if it is finally back on track this year. Costs have been cut, the company has taken action to get its debts under control, and at the beginning of July, the firm announced that it had made a “world-classoil discovery offshore in Mexico. Higher oil prices should be the last piece of the puzzle. 

After three years of losses, City analysts expect the company to return to profit this year, with a pre-tax profit of £21.1m and earnings per share of 0.05p projected — not much, but it’s a start. 

For 2018, based on current oil price projections, the company’s pre-tax profit is expected to hit £129m and earnings per share are set to come in at 13p.

Unfortunately, these projections are down substantially from the City estimates issued earlier in the year. Only four months ago, analysts were projecting a pre-tax profit of £42m for 2017 and £209m for 2018. 

These volatile figures help explain why I remain cautious on Premier despite the company’s recent rally. The firm’s outlook is improving, that’s for sure, but there’s still a lot to do before it returns to its former glory. What’s more, oil prices may not remain elevated for long.

Higher prices have removed the need for OPEC to reduce production and the cartel might now decide that its time to increase output, which would weigh on prices. 

Plenty of work to do

As well as the uncertain outlook for oil, Premier’s debt pile is concerning. The £2.2bn debt mountain is nearly six times more than the company’s market value (£374m at the time of writing), and before investing, I’d want to see some substantial progress on debt reduction. If debt starts to decline substantially, that’s a clear message that the firm is on the right path to success. 

So overall, even though shares in Premier have rallied substantially since the middle of the year, I’m not buying just yet. 

Uncertainty continues to surround the business. Granted, oil prices have risen to a multi-year high, but at the company level there’s still plenty of work to do. The company has to prove that’s it’s making the most of the beneficial environment before it becomes an attractive investment once again. 

Building the perfect portfolio

Turnaround stocks like Premier can produce enormous returns for investors. Unfortunately, they can also cost you thousands if the turnaround fails. So, the best way to profit from such opportunities is to hold them as part of a well-diversified portfolio. 

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Rupert Hargreaves owns no share 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.