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The Premier Oil share price is up 75%. Here’s what I’d do now

The Premier Oil (LSE: PMO) share price has been one of the top performers in the FTSE 250 over the last year. The stock is now up by around 75% from its 52-week low of 65p.

Recent gains were triggered by news that the company will spend up to $871m acquiring oil and gas fields in North Sea.

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As my colleague Alan Oscroft explained recently, these deals might seem surprising for a company that already carries a lot of debt. In this article I want to take a closer look at this news and give my view on whether the shares deserve a buy rating.

What’s happening?

Premier will spend $625m acquiring the Andrew and Shearwater assets from BP. The company says that Andrew will add about 18,000 barrels of oil equivalent per day (boepd) to the group’s production, while Shearwater will provide a “significant producing and infrastructure hub”, plus 25m boe of reserves and resources.

PMO will also spend up to $246m buying an additional stake in the Tolmount field from Dana Petroleum.

These acquisitions will be funded by a $500m equity placing, plus the firm’s existing cash resources and — if needed — a $300m short-term loan.

What’s notable is that is Premier isn’t planning to use any new long-term debt to fund this deal. Shareholders will pay, instead. In the meantime, the firm’s lenders will receive higher interest payments in return for extending their existing loans from 2021 to 2023.

Does it all add up?

In my view, the numbers look good on this deal, at least for the firm’s lenders. Premier says that the new assets should generate an extra $1bn of pre-tax free cash flow by the end of 2023. That’s equivalent to a gross return of 15% on the $871m it will cost to buy the fields, in just four years.

Tax costs should be minimised because Premier already has $4.2bn of UK tax losses it’s trying to use up.

Of course, the company will incur slightly higher finance costs as a result of these acquisitions. But they look affordable to me. Indeed, I believe that these acquisitions will help the firm to repay its existing debt more quickly.

All in all, this deal looks good for Premier’s lenders. So are the shares a buy, too?

Don’t forget decommissioning

Many fields in the North Sea are nearing the end of their productive lives. This is one reason why big players such as BP are selling them.

Premier’s new assets are a good example. From 2025 onward, the company expects to incur decommissioning costs of $600m on these fields. That’s a lot of money for a company that generated revenue of about $1,600m last year.

These acquisitions will boost cash flow and help to repay debt over the next few years. But beyond that, I think decommissioning could start to be a drain on cash.

Judging the fair value of PMO shares has become difficult, in my opinion. Although the stock looks reasonably priced on 12 times 2020 forecast earnings, remember there’s no dividend and lots of debt.

You can buy BP shares on a similar valuation and gain a 6.4% yield and the safety of a much larger, more diverse business. I believe longer-term investors will probably do better with this FTSE 100 heavyweight.

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Roland Head 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.