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Is Premier Oil undervalued or should I buy this FTSE 250 income stock?

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Silhouette of an oil rig
Image source: Getty Images.

2018 has been an eventful year for shareholders of Premier Oil (LSE: PMO). Between the beginning of the year and the beginning of October, shares in this oil producer doubled, following the oil price higher.

However, since the beginning of October, the price of oil has been trending lower, and Premier’s shares have followed suit. Since peaking at 143p, they’re now changing hands for just 70p, roughly where they started at the beginning of the year.

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Today, I’m going to be considering whether or not it is worth buying shares in Premier after the recent declines, or if you should give up on the company in favour of FTSE 250 income play OneSavings (LSE: OSB).

Oil volatility

The way I see it, as the price of oil has fallen, investors have indiscriminately dumped shares in any companies that have exposure to the oil industry. Premier’s sell-off has been so severe because investors are worried about the group’s borrowings — an issue the business has had for some time. However, this year the group has taken serious strides towards reducing its leverage.

Oil production is on track to end the year at 80,000 barrels of oil per day (kboepd), up from 76.2 kboepd in the first half of 2018, at an average operating cost of $17–$18/bbl. Debt is already falling (from $2.7bn at the end of 2017 to $2.5bn at the end of October) and management has taken the prudent step of hedging a portion of the company’s production in 2019. Around 30% of production is hedged at a price of between $69/bbl and $72/bbl, which guarantees a certain level of income for the business over the next 12 months, even though the oil price is about $20 below this level.

With production rising, output hedged and debt falling, Premier is benefitting from a triple tailwind of higher oil prices, increased production and lower debt costs. And with this being the case, I think the stock is worth more than it was at the beginning of the year. Although considering the uncertain outlook for oil prices, it’s difficult to try and place an exact value on the shares. 

On the other hand, trying to place a value on the shares of OneSavings is easier. In comparison to Premier, the bank’s income is relatively predictable, because products like mortgages and loans have a fixed interest rate for many years. City analysts are expecting the company to report earnings growth of 4% in 2018, and 7% for 2019. 

Granted, this rate of growth is not going to win any awards, but it is predictable. 

Undervalued? 

Despite the aforementioned steady growth, shares in the company look cheap. They are currently changing hands for just 6.4 times forward earnings. Despite all of the uncertainty facing the UK as it prepares to leave the EU, I think the multiple severely undervalues the business and its prospects. 

Indeed, the rest of the banking sector is trading at an average P/E of around 8, implying the shares are undervalued by approximately 25%. On top of this discount valuation, investors are also entitled to a dividend yield of 4.1%. 

Unfortunately, at this point, Premier doesn’t offer a dividend. So overall, while shares in Premier might look cheap after recent falls, because we don’t know what the future holds for the price of oil, I think OneSavings is the better buy today.

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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.

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