Is it game over for the Premier Oil share price?

Roland Head explains why he thinks Premier Oil plc (LON:PMO) has been hit so hard by the falling price of oil.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

It’s been a painful few weeks for Premier Oil (LSE: PMO) shareholders. The oil and gas producer’s share price has fallen by more than 50% since the start of October, when it hit a 52-week high of 146p.

As a shareholder, I have a keen interest in this situation. So today I’m going to take a fresh look at Premier. I’ll explain why the share price fall has been so brutal, and ask whether the shares are still worth buying.

What’s really happened

You probably already know that the price of Brent Crude oil has fallen by around 30% since the start of October, from a high of $86.70 to about $60.

Should you invest £1,000 in HSBC right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if HSBC made the list?

See the 6 stocks

It’s no surprise that oil stocks have suffered. But you may wonder why Premier’s share price has fallen by over 50% when the price of oil has only dropped about 30%.

There’s a good reason for this. The cost of producing a barrel of oil is relatively constant over short periods. For our purposes, we can consider it to be a fixed cost. This means that if the price of oil rises, the extra sales revenue is almost all profit.

In a rising market, the firm’s profits from selling oil will rise more quickly than the price of oil. On the other hand, when the price of oil falls, Premier’s profits will fall more quickly than the oil price. This is an effect known as operating leverage.

Although I’ve simplified it considerably, I estimate that a 10% increase in the price of oil could increase Premier’s profits by as much as 14%. I hope this makes it easy to understand why oil shares can move so sharply when the price of oil changes.

Still making good progress

A recent trading update made it clear that Premier is still making good progress. Production is up, spending is down, and operating expenses are under control, at $17-$18 per barrel.

The firm has also put in place new hedging contracts for 2019, covering over 30% of planned production. They guarantee a minimum oil price of $69 per barrel during the first half of the year, and of $72 per barrel during the second half.

Chief executive Tony Durrant expects net debt to fall by $320m to $2.4bn this year, which he says will reduce the group’s net debt-to-EBITDA ratio to 3x. Although this is still high, Mr Durrant expects this ratio to fall further in 2019. I believe this could open the door to a more normal valuation for the firm.

Too cheap to ignore?

Broker forecasts for 2018 and 2019 have actually risen over the last three months, despite October’s oil price slump. Analysts appear to remain confident that the company can return to profit and continue repaying its debts.

If that view is correct, the stock’s 2018 forecast price/earnings ratio of 4.6 may be too cheap. A forecast P/E of 2.7 for 2019 also seems to be pricing in a lot of bad news. I continue to rate the shares as a buy.

Should you invest £1,000 in HSBC right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets.

And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if HSBC made the list?

See the 6 stocks

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of Premier Oil. 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.

More on Investing Articles

Hand flipping wooden cubes for change wording" Panic " to " Calm".
Dividend Shares

2 ‘safe’ LSE dividend stocks to consider as global markets sell off

As global markets experience high levels of volatility due to economic uncertainty, investors are piling into these ‘safe-haven’ dividend stocks.

Read more »

Investing Articles

US stock market rout: an unmissable opportunity for investors?

His tech-heavy portfolio has been smashed by Trump’s tariffs. However, Dr James Fox believes there could be some opportunities in…

Read more »

Investing Articles

After a 13% ‘Trump tariff’ fall, is the Barclays share price too cheap to miss?

Does the Barclays share price fall mean we should all panic and run screaming from the stock market? Nah, of…

Read more »

Mature Caucasian woman sat at a table with coffee and laptop while making notes on paper
Investing Articles

2 investment trusts to consider for a Stocks and Shares ISA

These two investment trusts have a different focus -- but our writer sees both as worth considering, one more for…

Read more »

Investing Articles

Deutsche Bank reiterates Buy rating on 9.6% yielding FTSE 250 stock that was “most shorted in UK”

Our writer investigates why a major broker remains optimistic about a FTSE 250 stock that was once the most shorted…

Read more »

Investing Articles

2 things to remember when stock markets are turbulent

US trade policy has rattled the stock markets in New York, London and elsewhere. Our writer outlines a couple of…

Read more »

Investing Articles

Are Trump’s tariffs a once-in-a-lifetime chance for ISA investors to get rich?

The £20,000 Stocks and Shares ISA limit will reset on 6 April. Smart investors could use current market volatility to…

Read more »

Investing Articles

Here are the latest Persimmon share price and dividend forecasts

Our writer looks at the latest forecasts for the Persimmon share price and considers what level of dividend the stock…

Read more »