It might seem odd to label Premier Oil (LSE: PMO) and Genel Energy (LSE: GENL) growth stocks, but now the price of oil has stabilised, I believe that is precisely what they are.
Today’s full-year 2017 figures from Genel support this conclusion. After a year of consistent oil payments by the Kurdistan Regional Government and reduced capital spending, the company was able to generate free cash flow before interest payments of $142m during 2017, more than double the figure reported for 2016, even though production slumped from 53,300 barrels a day to 35,200 bbl/d. Revenue increased to $229m from $191m and operating profit reported for the period hit $298m.
Turnaround in progress
Management expects 2017’s performance to continue into 2018. Production is expected to remain constant at around 32,800 bbl/d, and capital spending is projected to be no more than $140m.
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Considering these targets, it looks as if the company is on track to report another year of substantial free cash generation in 2018. Valuing the business on free cash flow generation alone, the shares are currently trading at a historical price to free cash flow ratio of around four, which is significantly below the oil and gas sector median of 16.
That being said, due to the risks surrounding Genel’s operations in the Middle East, it’s unrealistic to expect that the shares would trade at a sector median valuation. However, such a deep discount the rest of the sector is, in my view, unwarranted. If the company repeats its 2017 performance this year, the market may take a different view of the business and award the shares a higher valuation, that’s why I’m considering buying in April ahead of this re-rating.
Paying down debt
I also believe shares in Premier could re-rate as well, as the company builds on its robust 2017 performance.
Last year it generated a positive free cash flow of $71.2m, allowing it to marginally reduced debt to $2.7bn (and my Foolish colleague Roland Head believes it has already fallen further). This free cash flow was achieved on average production of 75,000 bbl/d and management is currently guiding for production of between 80,000 to 85,000bbl/d for full-year 2018. The average realised oil price for 2017 was $52.1bbl, compared to today’s price of $69.1bbl (a third higher). Some of Premier’s production for 2018 is hedged at a lower price, but generally speaking, the firm should benefit tremendously from the uplift in oil prices during 2018.
Put simply, these figures suggest Premier is going to produce a13% more oil next year at a price 30% higher than achieved during 2017. This should allow the group to pay down a large chunk of debt, proving to the market that it is not going to go out of business anytime soon. And when debt does begin to fall meaningfully, shares in Premier should re-rate higher.
Indeed, today the stock is trading at an extremely depressed forward P/E of just 5.7, as the market still doubts the firm’s ability to be able to pay down its massive debt obligations. So, when Premier finally proves it has its finances under control, there’s scope for the stock to double as it returns to a sector average valuation.
