Shares in debt-laden North Sea oil producer Premier Oil (LSE: PMO) have fallen by 20% over the last five weeks.
One reason for this is that oil prices have fallen sharply over the same period. But oil price aside, are there any other factors shareholders should be aware of? And are Premier shares still cheap?
I’ve been taking a closer look and will give my verdict below. I’ll also consider the investment case for another oil stock that looks cheap to me but offers limited visibility for shareholders.
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Good progress
A trading update in May suggests that PMO boss Tony Durrant is continuing to deliver on his operational and financial targets.
Mr Durrant has increased production guidance for the year from 75k to 75k-80k barrels of oil equivalent per day (boepd). He also advised investors that if oil prices stayed the same, debt reduction would be at the top end of the firm’s $250m-$350m target for the year.
It was a solid update that didn’t raise any red flags for me.
Are the shares still cheap?
As I’ve written before, Premier shareholders need to remember that the firm’s valuation is still dominated by its enormous debt pile.
Net debt fell from $2.33bn to $2.25bn (about £1.75bn) during the first four months of 2018. But that still dwarfs the market value of the firm’s shares, which is about £685m.
What this means is that when valuing these shares, we need to look at the firm’s enterprise value (market cap + net debt) to get the full picture.
At the time of writing, Premier’s enterprise value was about £2.5bn. That’s about 7.5 times last year’s free cash flow, which looks pretty affordable. The equivalent figure for Tullow Oil is about 11, for Royal Dutch Shell it’s around 12. However, both of these larger companies pay dividends and benefit from stronger balance sheets than Premier.
In my view, Premier shares are probably fairly valued at current levels. As debt continues to fall I’d expect the shares to make further gains. But the share price will remain very sensitive to changes in the oil price, so shareholders may need to be prepared for a lively ride.
A true bargain?
One oil stock that’s failed to benefit from strong market conditions is Asia-focused SOCO International (LSE: SIA). This former favourite has continued to drift lower over the last year and now trades at just 66p. That’s a 33% discount to the stock’s net asset value, which I estimate at 99p per share.
Why is SOCO so cheap? Unlike Premier and Tullow, it has net cash and a track record of generous dividends — the stock currently has a forecast yield of 6.8%. Another plus is that founder and CEO Ed Story still has a 3.5% shareholding, suggesting his interests should be well aligned with those of shareholders.
I think one reason why this stock keeps drifting lower is that the market isn’t sure where this business is going. Its Vietnam assets remain cheap to run and cash generative. But we don’t yet have much information about the performance of Merlon, a recent acquisition in Egypt.
In my view, SOCO carries some risk. However, the company’s historical performance and its focus on cash generation suggest to me that the shares should probably be worth more. I’d rate the stock as a contrarian buy.
