Why I won’t be buying these two stock rockets

Jolly Roger pirate flag

Perky production news from Premier Oil (LSE: PMO) has helped to power the driller’s share value to six-week highs this week.

On Wednesday, Premier announced that, at its Zama-1 exploration well in Block 7 off the coast of Mexico, it had made what it described “a world class oil discovery.” The news saw the stock leap 36% on the day, pulling it to its highest level since late May.

The London driller — which owns a 25% stake in the asset — said that Zama-1 could hold more than 1bn barrels of the black stuff. It has described the well as “a commercial standalone development which adds materially to Premier’s portfolio of assets worldwide.”

In other news…

Premier’s share price remained stable on Thursday following the release of latest financials, the company advising that first-half production of 82,100 barrels of oil equivalent per day beat guidance and was up 34.5% from the corresponding 2016 period.

While the company kept its full-year production target unchanged at 75,000 barrels per day, it advised that this “will be reviewed on completion of the summer maintenance period.”

This was not the only good news at Premier. Operating costs fell 11% during January-June, to $14.70 per barrel, it advised, while the firm’s full-year capital expenditure target was reduced to $325m from $350m previously.

Furthermore, positive cash flow in the period helped net debt fall to $2.7bn as of June, down from $2.8bn at the close of 2017.

Risks exceed possible rewards

While recent newsflow from Premier has undoubtedly been pretty terrific, I would not be surprised to see its share price shuttle lower once again.

Prior to this week’s releases the driller’s share price had been sinking in 2017 as the steady ramp-up in US production, allied with rising scepticism over the impact of OPEC’s supply-cutting drive, has put Brent values on the back foot. Indeed, Premier is still trading at a 35% discount to January’s highs of 96p per share.

The City expects the fossil fuel giant to finally flip into the black with profits of around £42m in 2017. But as the risks to Premier’s long-term profitability continue to mount, I for one will be remaining on the sidelines.

Supply fears

Diversified mining colossus Rio Tinto (LSE: RIO) is another commodities play I continue to steer well clear of.

Like Premier Oil, the iron ore giant has enjoyed decent share price momentum in recent times, the stock gaining 15% in a little over three weeks. Rio Tinto has leapt as prices of the steelmaking ingredient have ticked higher again — ore values boomed above $65 per tonne just this week, the highest since early May.

But although Chinese demand remains stable, I believe the vast tonnages of low-cost supply entering the market from Australasia and South America could prompt a calamitous retracement in the iron ore price. And my concerns are evident in broker forecasts, with expectations of a 57% earnings rise at Rio in 2017 to be followed by a 22% reversal next year.

A very-low earnings multiple of 10 times is not enough to convince me to invest, I’m afraid.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has recommended Rio Tinto. 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.

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