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Is the Premier Oil share price the bargain of the year?

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Will 2019 be the year when oil investors can breathe a sigh of relief and start to book gains?

In my view, the outlook is good. The price of oil is back on track and oil producers are keeping a tight grip on costs. Today I want to explain why I remain confident that the Premier Oil (LSE: PMO) share price should continue to rise.

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Big improvements in 2018

Premier Oil’s recent results show that the company delivered exactly what the doctor ordered in 2018. Oil and gas production hit a new record of 80,500 barrels of oil equivalent per day (boepd), as the Catcher field in the North Sea ramped up production.

On the finance front, Premier moved back into the black with an after-tax profit of $133.4m. Net debt fell by $393m to $2.3bn. The company’s ratio of net debt-to-earnings before interest, tax, depreciation and amortisation (EBITDA) fell from 6x to 3.1x. Although this ratio is still high, it’s now comparable with companies operating on a stable footing. I think it’s fair to say that Premier Oil is no longer in financial distress.

How cheap are the shares?

My sums show me that the firm’s stock is trading at about 4.1x 2018 free cash flow. This is exceptionally cheap. Of course, the main reason for this is that most of Premier’s free cash flow is needed to service its debt. In 2018, interest payments alone totalled $228.7m. That’s 43% of the group’s operating profit for the year.

Looking ahead, the stock trades on about 6x forecast earnings for 2019. I can see two opportunities for the shares to re-rate to a higher valuation.

The first is that as debt falls, the value of the group’s equity should rise to reflect this.

The second opportunity is that growth projects such as Zama (Mexico) and Sea Lion (Falkland Islands) will deliver commercial reserves and production.

The company expects to report progress in both areas in 2019.

What about the price of oil?

There are other factors that could affect Premier’s share price. The biggest of these is probably the price of oil.

Although low costs mean that the company generates free cash flow at all prices above $45 per barrel, a $5 movement in the price of oil results in a $60m change to free cash flow.

We saw how volatile the price of oil can be late last year. Brent Crude hit $85 in September, before dropping to $50 in December.

As I write, the oil price is about $67. My impression is that this is a comfortable level for most companies. It’s high enough for producers to make good profits, but not so high as to risk destabilising the market.

Buy, sell or hold?

Premier Oil’s high debt levels and exposure to the price of oil mean that it remains a speculative stock, in my view. But this company has a good track record of delivering projects successfully and running its operations well.

In my view, the shares could easily rise by 50% to 100% over the next couple of years. I view this as a buying opportunity, and continue to hold.

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Roland Head owns shares of Premier Oil. 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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