The last few years have been incredibly challenging for oil and gas producers such as Premier Oil(LSE: PMO). The falling oil price has caused revenue across the industry to decline, which has squeezed profitability and pushed many companies into the red. In response, costs have been cut and strategies have been changed. With valuations now at a low ebb, it could be the perfect time to buy oil and gas producers for the long run.
Premier Oil released an encouraging set of interim results on Thursday. They showed that the company has been able to increase production and maintain a disciplined approach to its finances. Production in the first half of the year was a record 82,100 barrels of oil equivalent per day (boepd), and the company expects to deliver between 75,000 and 80,000 boepd for the full year.
Higher production meant improved financial performance, with positive free cash flow and after-tax profit of nearly $41m. This shows that the business has long-term potential - especially since it has been able to reduce operating costs by a further 11% to just $14.7 per barrel. Further cuts could help to make the company even more competitive versus peers, and could push its bottom line into the black over the course of a full year.
The decision by the company to strengthen its balance sheet appears to be a sound one. It is aiming to have a leverage ratio which is no more than three times EBITDA (earnings before interest, tax, depreciation and amortisation) by the end of 2018. Not only does this have the potential to create a more sustainable and lower-risk business, it may also improve investor sentiment to a significant degree. And with the stock trading on a forward price-to-earnings (P/E) ratio of just 3 using 2018's forecast earnings, it appears to have a wide margin of safety.
Clearly, the financial and share price performance of the company in future years is highly dependent on the price of oil. The industry seems to now be preparing itself for a prolonged period of low oil prices through cost reductions. However, with demand from the emerging world expected to increase in future years and the potential for more supply restrictions from OPEC, the reality is that the oil price has the capacity to gradually move higher. This could act as a positive catalyst on the Premier Oil share price.
Certainly, Premier Oil is a risky stock to own. Its balance sheet risk remains high, there is the prospect of more volatility in the oil and gas industry, and it is a relatively small player. However, its update shows that there is scope for further improvements in production, costs and debt levels. Given the wide margin of safety which is on offer through a low valuation, it could be worth buying for the long haul alongside other larger and more diversified resources stocks.
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Peter Stephens has no position in any of the shares mentioned. 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