Why the Premier Oil share price could storm ahead of the FTSE 250

Oil pipes in an oil field
Oil pipes in an oil field

Shares of oil and gas producer Premier Oil (LSE: PMO) edged higher this morning, after the firm reported a 141% increase in pre-tax profit for the first half of 2018.

Premier's share price has stormed ahead of the FTSE 250 over the last year, rising by more than 110%. The business now appears to be well on the way to recovery from a debt-fuelled meltdown that could have left shareholders with nothing.

There are still some challenges ahead. But as I'll explain, I believe this 84-year old business is now in good shape to deliver sustainable growth for shareholders.

Delivering the goods

As a shareholder, I was looking for three things from today's half-year figures.

  • The first was evidence that cash flow and profit are rising strongly.

  • The second was a reduction in net debt.

  • And the third was confirmation that Premier's record of operational excellence was continuing.

Having looked through today's figures, I'm happy on all three counts. The company says that production from its Catcher field in the North Sea has now reached its target level of 60,000 barrels of oil equivalent per day (boepd).

When combined with production from the group's other assets, management is confident that full-year production will be in line with guidance of 80,000-85,000 boepd. Operating expenses are expected to remain within budget, at between $17 and $18 per barrel.

Improved cash generation as a result of Catcher production enabled the group to cut net debt from $2,724m to $2,650m during the first half of the year. Chief executive Tony Durrant expects to report a reduction of $300m-$400m by the end of 2018.

This is encouraging progress in my view, although some risk remains. The firm's interest costs are currently running at 7.1% per year. Premier made cash interest payments of $125m during the first half, putting a sizeable dent in its cash flow.

A return to growth

There are two major growth projects on the horizon at the moment. The first is the Tolmount gas field in the North Sea, which the firm says is comparable in size with Catcher. This project will now go ahead, thanks to a series of partnerships that limit the cash Premier has to invest to $120m.

The second big growth opportunity is the Sea Lion oil field, off the coast of the Falkland Islands. Mr Durrant says that work is under way to secure funding for this project. This could produce oil for 20 years, with peak production of more than 120,000 bopd.

Target price 200p?

In my view, the big opportunity for Premier is to increase earnings while reducing debt. This combination should reduce the impact of the group's finance costs and boost after-tax profits.

Analysts expect the group's profits to rise sharply next year. Consensus forecasts show earnings of $0.15 per share for 2018, rising by 140% to $0.36 per share in 2019.

These forecasts put the stock on a 2018 forecast P/E of 10.2, falling to a P/E of 4.3 in 2019. A share price of 200p would put the stock on a 2019 P/E of about 7.2. If oil prices remain stable and the group delivers debt reduction in line with guidance, I think the shares could hit 200p during the next 18 months. This would give upside potential of about 60% from current levels.

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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.