Last week, Premier Oil (LSE:PMO) announced it had achieved first oil from its $1.6bn North Sea Catcher project. This is very significant news for Premier, with Catcher’s success being critical to the company’s plans to effectively reduce its debt pile. As we wave goodbye to 2017, is it time to consider Premier Oil for a recovery play in the New Year?
Over the next couple of weeks, the Value The Markets team is going to highlight a number of stocks we believe are potentially set for strong growth in the year ahead. Our first pick is the UK Producer and explorer Premier Oil, which has endured a very turbulent 2-year period.
Oil Price Crash
The company got caught out by the oil price crash after committing to large capital expenditure when oil prices were around $100 a barrel. With Brent subsequently dropping as low as $27 in 2016, Premier saw its net debt climb to $2.8bn by May 2017.
After its share price hit a low of 19p in January 2016, it would have been near impossible for Premier to raise sufficient funds in a straightforward placing. Instead, CEO Tony Durrant struck a deal with Bond Holders that he suggested was not ‘materially dilutive’.
It was a long drawn out process but refinancing was completed in July 2017, pushing debt maturities back to 2021 and beyond. In the deal, it was agreed that $245m of Convertible bonds would see an increase in coupon rate from 5% to 6.5% and have an amended conversion price of 74.71p. In addition, bondholders were given warrants equivalent to 3.33% of their value at an exercise price of 42.75p.
Thus far there has been minimal conversion, although the share price has appeared to be weighed down somewhat by considerable shorting. According to figures from Euroclear, total shorts in Premier Oil almost doubled from around 16% in February 2017 to 28% in March 2017. This coincided with the refinancing deal and the 3-week period in March where it was elected the volume weighted average price (VWAP) would dictate the conversion price of the Bonds.
Total shorts at the end of November 2017 were slightly down to around 25%, with shorts declared over 0.5% now at their highest levels, at 12.05%.
It may be the case that much of the shorting activity is down to the employment of a convertible arbitrage strategy. It’s a strategy that locks in the profit margin, holding simultaneous long and short positions. So far though, there has been a backdrop of positive operational news-flow, probably the most significant being the massive Zama discovery offshore of Mexico, of which Premier owns a 25% slice. The Initial gross original oil-in-place estimate is in excess of 1 billion barrels and will play a large part in increasing balance sheet assets.
Despite the good news and strong rise in oil price, the company still faces considerable risks. Longer-term Shareholders will remember the taste of disappointment with Premier’s previous underperforming large-scale project, Solan. There is still plenty to do to get Catcher up to speed and any strong reversal in oil price would reduce the chance of sizeable near-term debt reduction.
All the while the oil market remains buoyant however, the light at the end of the tunnel shines brighter, and today, Premier Oil appears to be in much better shape. The EON deal that came out of the darkness in 2016 looks to have been a spark of genius in hindsight and so far, the rehabilitation of the company’s finances has been smooth if not a little frustrating for holders.
By the end of Q3, average production was up to 76.6k Barrels of Oil Equivalent Per Day (boepd) for the year-to-date, and the company became cash flow positive in H1 2017.
Net debt is expected to reduce in the 2nd half of the year, but refinancing costs are likely to have increased General and Administrative (G&A) costs to around $150m. Usually, annual G&A expenditure is around the $25m mark and so gains in H2 will be impacted, but the underlining figures will surely point to the potential of better times ahead.
Increased production and netback
First Oil at the Catcher field has been achieved on schedule with an initial stabilized production rate of 10k bopd and this will be ramped up in phases. If all goes to plan, the company’s 50% share in the project is forecast to contribute as much as 30k bopd to Premier by the Summer.
If we take the existing forecast full-year production guidance of around 75-80k boepd, deduct 10k for the sales of the Wytch Farm and Pakistan assets, lose a further 5k due to natural decline, and add an average of 20k bopd for Catcher we arrive at 80-85k by end of 2018 with Production peaking at over 90k by the year-end.
Premier has already cut costs significantly and proposed Capital Expenditure is minimal and discretionary giving the company’s estimated break-even to be $45 or below in 2018. With Brent currently around $66, and only 25% of production now hedged in the mid $50s, those rough back-of-an-envelope calculations start to show positive cash flow of around $400-650m.
Asset sales will help reduce debt more quickly, the most notable to date being the sale of Wytch Farm, which will shave off $200m of debt. If all goes to plan with Catcher and the company can demonstrate it is making significant reductions in debt, this could potentially be a watershed moment for the sentiment of the stock and Premier Oil could well see its share price double in 2018.
Premier’s share price has been in a general upward trend since its historic low of 19p in early 2016. Support from the bottom of that medium-term channel is currently around 55p, with the top being 113p today. Current resistance of 82p was hit last week and once broken, I would expect a rise to challenge the £1 marker briefly touched in early 2017. Since July, the price action has been within a tighter range with 70p as bottom channel support. Those buying into the Premier recovery story might consider a good entry point to be in the low 70s but anything under 80p is looking increasingly good value.
Author: Stuart Langelaan
The author of this piece owns shares in the company written about above