Why I believe the worst is over for these two oil producers

The past few years have been rough for oil producers Premier Oil (LSE: PMO) and Tullow Oil (LSE: TLW), but I believe that after two years of pain, these producers are now on the road to recovery. 

Both have published positive trading updates recently. While both companies remain troubled following the oil price collapse, they’re heading in the right direction. 

For example, yesterday Tullow reported its full-year results for 2016 revealing that the group has begun to pay off its massive debt pile as cash flow turned positive during the fourth quarter. As the average price of Brent crude was just over $50 a barrel in Q4 of 2016, compared to $55 on average for the first few weeks of 2017, it looks as if Tullow’s cash flow generation has continued into the New Year. Around half of the company’s production is hedged for 2017. 

Booming production 

Tullow’s production is expected to come in at 85,000 bopd for 2017 after the company successfully brought its TEN project on stream last year. Capital spending is projected to fall to $500m from $900m last year as a result. 

Considering all of these figures, a simple back of the envelope analysis shows that it will be able to take a chunk out of its massive debt pile ($4.8bn at the end of 2016) this year. 

The group generated $800m in cash from operations last year. Based on the fact oil prices and production will both be above 2016 levels this year, it’s reasonable to assume the group will generate a similar amount of cash during 2017. Deducting $500m of capital spending from this figure gives a free cash flow of $300m, which should allow Tullow to reduce net debt by 6.3% to $4.5bn — not much, but its a start. 

Stable financials 

Like Tullow, Premier has also begun to pay down its debt pile as capital spending programmes come to an end, oil prices stabilise, and costs remain low. At the beginning of January, the company announced that it had begun to pay down debt in the fourth quarter and around a month later management announced the company had reached a deal with its creditors regarding refinancing. 

Now that this hurdle is out of the way, Premier can concentrate on its day-to-day business and paying down debt. City analysts are expecting its revenue to rise by around 25% this year on the back of higher production and higher oil prices, and a further 30% increase in output is expected next year. If this growth emerges, it should be able to pay down its debt and return to stability quickly, considering the company started to settle obligations with creditors at the end of last year. 

When it’s clear Premier’s finances are stabilised, investors should flock back to the enterprise. Based on current forecasts the shares are trading at a forward 2018 P/E of just 3.2.