The Premier Oil (LSE: PMO) share price has slumped in value this year. Shares in the oil and gas producer have fallen nearly 80% since the beginning of 2020. After this decline, the stock is trading at one of its lowest levels in five years.
If you are interested in buying the stock after this slump, here’s what you need to know.
Premier Oil share price decline
Investors have been selling the Premier Oil share price this year as the price of oil has plunged.
The North Sea oil producer requires high oil prices to meet its high capital spending and debt repayment plans. Falling prices have led to a cash squeeze at the business. Management has had to pull out all the stops to prevent the company from going under. Luckily, it looks as if these efforts have stabilised the business.
However, the oil company faces a long road to recovery. This could hold back the Premier Oil share price in the near term.
Based on the company’s current production and cost forecasts, City analysts are expecting it to produce a loss for 2020 and 2021. This makes it difficult to estimate the firm’s value. What’s more, if oil prices continue to fall, Premier’s outlook could even deteriorate further.
As such, it doesn’t look as if the company is out of the woods yet. A prolonged period of low oil prices would place further stress on the corporation’s balance sheet. This would prolong its recovery.
High risk, high reward
Having said all of the above, if oil prices do rise substantially from current levels, the Premier Oil share price could be an excellent investment.
For example, if the price of oil returns to levels last seen in 2019, my figures indicate that the stock is trading at a forward price-to-earnings (P/E) multiple of less than two.
That’s compared to the oil and gas sector average of around 10. As such, a return to the sector average could see the Premier Oil share price rise fivefold from current levels.
The bottom line
Overall, all it looks to me as if the Premier Oil share price is a high-risk, high-reward opportunity. If the price of oil continues to languish at current levels, the company is going to have a hard time in the next few years, reducing debt and growing output.
On the other hand, if the price of oil rises by 20% to 30% from current levels, the group’s profits could surge, which may lead to a substantial increase in the Premier Oil share price.
The best way to benefit from this potential while limiting downside risk could be to own the stock as part of a diversified portfolio. I think this would allow investors to profit if oil prices returned to 2019, but reduce losses if Premier runs out of funds.
Rupert Hargreaves 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.