Premier Oil (LSE: PMO) released half-year results this morning, reporting a profit after tax of $167m, largely thanks to a $63m tax credit and a $101m gain on decommissioning estimates (due to the weakness of sterling against the dollar) being credited to the income statement.
Cash on the balance sheet fell $194m over the six-month period, despite a further drawdown of bank loans to the tune of $230m. Premier’s policy is to maintain a long-term gearing ratio (net debt divided by net assets plus net debt) of below 50%. The table below shows how gearing has spiralled upwards over the last couple of years as the low oil price has taken its toll.
| 30 Jun 2016 | 31 Dec 2015 | 30 Jun 2015 | 31 Dec 2014 | |
| Net debt ($bn) | 2.635 | 2.242 | 2.093 | 2.122 |
| Net assets ($bn) | 0.855 | 0.735 | 1.433 | 1.872 |
| Net assets plus net debt ($bn) | 3.490 | 2.977 | 3.526 | 3.994 |
| Gearing ratio (%) | 75.5 | 75.3 | 58.8 | 53.1 |
As you can see, net debt has increased. Meanwhile, net assets have declined, with a modest rise reported today, being less than the increase in net debt. To put the elevated 75.5% gearing ratio into context, a ratio of 50% would require Premier to raise $1.78bn (£1.36bn) of new equity — around three-and-a-half times the company’s current market capitalisation.
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Premier has been in negotiations with its lenders for months about amending financial covenants and extending debt maturities. Today it reported “substantial progress” and said it “expects negotiations to conclude and revised agreements to be implemented during H2 2016.”
Lenders should be cheered by the good operational performance during the first half of this year, which has led the company to up its full-year production guidance by 4%. Furthermore, management said: “The second half of the year will see Premier transition from a period of heavy investment to one where at oil prices above $45/bbl we can generate free cash flow.”
Premier remains somewhat at the mercy of the oil price and its lenders. And I do wonder if the latter might require the company to raise at least some equity as a condition of any refinancing, particularly if the price of oil were to begin moving adversely again. For this reason, I’ll continue to watch from the sidelines at this stage.
A more solid investment
I see Royal Dutch Shell (LSE: RDSB) as a more attractive investment proposition right now. If you compare the table below with that for Premier Oil above, you’ll readily grasp the relative financial strength of the FTSE 100 giant.
| 30 Jun 2016 | 31 Dec 2015 | 30 Jun 2015 | 31 Dec 2014 | |
| Net debt ($bn) | 75.107 | 26.627 | 25.960 | 23.933 |
| Net assets ($bn) | 192.506 | 164.121 | 178.008 | 172.786 |
| Net assets plus net debt ($bn) | 267.613 | 190.748 | 203.968 | 196.719 |
| Gearing ratio (%) | 28.1 | 14.0 | 12.7 | 12.2 |
Shell’s net debt has risen dramatically due to the mega-acquisition of BG earlier this year, but net assets have also increased. While the gearing ratio has doubled, it remains relatively low and within the board’s target range of 0%-30% across the business cycle.
While there’s no chance of Premier paying a dividend any time soon, Shell is committed to extending its multi-decade record of never having cut its payout. It has levers it can pull to achieve that in all but the direst of environments, and with a current yield of over 7%, I rate the stock a buy.
