Energy stocks are in fighting form as Brent oil prices surge back to around $70 a barrel. This recovery is most obvious with the once-bedraggled exploration and production (E&P) players, such as London-listed Enquest and Premier Oil. These firms had a torrid few years as oil prices threatened to crash all the way down to $20 a barrel, making their main focus on expensive North Sea oil almost completely uneconomic.
Share prices plummeted and the panic also hit their bonds (see chart below). Both had tapped the retail-bond market to help fund their capital expenditure, which seemed a great idea until the oil price collapsed – at which point many retail investors overreacted by selling down their bonds at ludicrous prices. Most investors in distressed debt are comfortable with the idea that recovery rates on bonds in trouble are usually somewhere between 50p and 70p in the pound. Yet at varying points over the past few years, Enquest’s retail bonds have traded below 50p in the pound.
Both Enquest and Premier realised their debt levels were too high and that bond investors were signalling a very real risk of default. This forced both to start renegotiating with their bondholders to stabilise their finances. That painful and protracted process finished with Premier Oil’s deal with its bondholders last year (Enquest agreed a deal back in 2016). Meanwhile, both firms have benefited from some very helpful tailwinds at the operational level. The oil price has risen, while crucial new fields under development – which required all that capital expenditure – have also started to come online, kicking in extra cash flow.
In better shape
I’ve championed these bonds both here and in my column for the Financial Times before, and I am a very happy investor in both. The more obvious investment case is for Premier Oil’s bonds. As part of the restructuring, Premier agreed to a higher interest rate of 6.5% per annum through to 2021 – a yield to maturity of around 6.75% at the current price. Bond investors are also being paid additional equity, via warrants that are triggered above 42.75p a share (Premier’s share price is now around 100p). So investors get a chunky yield for the next three years and some of the potential upside from the shares.
The Enquest bonds are for the more speculative investor. As long as the oil price stays below $65 a barrel, Enquest is now paying out an effective interest rate through to 2022 of 7% compounding per annum – but in new bonds rather than cash. If oil is above $65, it pays in cash. This is known as a payment-in-kind (PIK) toggle note.
Both Premier and Enquest are still highly leveraged – Premier has total debt of $2.7bn versus a market cap of £637m, while Enquest has $1.9bn of debt and a market cap of £448m. That makes both of these bonds risky. If the oil price crashes again, both could be in trouble once more. However, both are in much better operational shape and are churning out cash, which should increase as their production levels rise. I’m bearish about oil, but I don’t think prices will slip much out of a $40 to $60 range. If that is the case, both Premier and Enquest might survive even at lower prices than today. There are risks, but Premier in particular looks a decent bet for a risk-tolerant income investor.
Markets signal better prospects
The more confident outlook and successful restructuring of Enquest and Premier Oil has been reflected in the price of their retail bonds. The Enquest 2022 notes have recovered from a low of just under £30 to £88 now. The Premier Oil 2021 notes are almost back to their issue price at £99.
|Exchange||LSE ORB||LSE ORB|
|Original maturity||15 February 2022||11 December 2020|
|Original type||Fixed rate, unsecured||Fixed rate, unsecured|
|Revised maturity||15 April 2022||31 May 2021|
|Revised type||PIK toggle, unsecured||Fixed rate, secured|
|Other revised terms||Extendable to October 2023||Equity warrants|
|Payments||15 February, 15 August||11 June, 11 December|