Interactive Investor

Stockwatch: can you trust this mid-cap share at an inflection point?

He’s tipped this share before, and the original reasons for favouring upside still apply. A director has also bought heavily, which analyst Edmond Jackson believes is another positive signal.

26th January 2024 11:13

Edmond Jackson from interactive investor

I feel like a moth returning to a flame, but despite a modest let-down from Tullow Oil (LSE:TLW), I think it pertinent to note it has declared a strong outlook and a director is continuing to add to their 22 million shareholding. 

Yesterday’s pre-close update asserted continued debt reduction via operating cash flow, and a progressive operations update for Tullow’s West African interests. Non-executive director Roald Goethe – appointed nearly a year ago, with extensive experience of the African energy industry – has yet to buy more stock, but accumulated 1.85 million from 26.7p last June, latterly 200,000 shares at 38.3p at the end of December. 

The company started 2024 weakly, dropping to 30p, but rose 3% to 34p yesterday, capitalising Tullow at just over £500 million. With Middle East tensions liable to persist and assuming no serious recession, Tullow has potential to capitalise on this firm oil price environment as its hedging contracts expire. 

The update did not specifically affirm market forecasts, but consensus has anticipated net profit of $283 million (£222 million) for 2023, rising to $421 million in 2024 – a genuine “inflection point” for the business when you consider the eight-year context: 

Tullow Oil - financial summary
Year end 31 Dec

reporting in US$

Turnover ($ million)1,6071,3601,8852,0481,7251,3961,2851,783
Operating margin (%)-68.1-
Operating profit ($m)-1094-75522.4528-1,385-1,018527734
Net profit ($m)-1035-600-17684.8-1694-1,221-80.749.1
Reported EPS (cents)-96.7-56.0-13.75.9-121-86.6-5.73.3
Normalised EPS (cents)-17.08.921.719.2-26.6-26.3-3.116.5
Op cash flow/share (cents)91.447.995.183.789.849.555.572.6
Capex/share (cents)16396.323.930.637.130.516.720.6
Free cash flow/share (cents)-71.2-48.471.253.152.619.038.852.0
Dividend per share ($)
Cash ($m)356282284180289805469636
Net debt ($m)3,9824,7254,8684,4524,2083,5823,2632,821
Net asset value ($m) 3,1552,2302,7062,893984-210-466-459
Net assets/share (cents)295 20819520869.9-14.9-32.5-31.9

Source: historic company REFS and company accounts.

A valuation conundrum  

This implies sterling earnings per share (EPS) equivalent of around 15p rising to over 21p, for a seemingly ridiculous forward price/earnings (PE) ratio of just 1.6x. With debt reduction a priority, however, there are no dividends, and last June’s interim balance sheet had $227 million negative net assets given $2.2 billion gross debt and $566 million deferred tax liabilities. Intangible exploration assets were not heavy though at $286 million.  

Tullow has by far the lowest PE of any oil & gas stock I can find, although it could be said that unless these companies are transforming towards green energy, they are more likely to be rated for yield. Indeed, BP (LSE:BP.) at 455p is on a 6.5x forward PE and 5.2% yield, and Shell (LSE:SHEL) at 2,400p is on 7.6x and 4.8%. 

But realistically, oil & gas will remain a key element to meeting overall energy needs, and my sense is that Tullow’s assets will eventually become integrated into a larger group. 

Medium-term trajectory is affirmed 

If you evaluate the business chiefly on stock behaviour, the last three years have been volatile-sideways, with a lurch down from a 30-40p area as low as 25p last year, as higher interest rates hit. Charts would say “Avoid”, counter to the previous executive chair saying Tullow is now “well-positioned for a positive and sustainable future” when she left later in 2021, having replaced the CEO and cut costs. 

The CEO since 2019 now says Tullow is “on track to deliver around $600 million free cash flow over the next two years, to achieve our stated target of around $800 million free cash flow from 2023 to 2025” assuming circa $80 oil. 

In fairness to the board of directors here, even if the stock does not reflect the progress, their guided numbers do. 

I drew attention to Tullow as a speculative “buy” at 45p in September 2021, significantly on what the departing executive chair was saying. This trade initially worked well by way of a rise to 62p by March 2022 before succumbing to expectations for rising interest rates.  

There was then a mid-2022 merger attempt at Capricorn Energy (LSE:CNE), which its shareholders rejected and made Tullow look as if it was getting lost. It was also possibly responsible for the stock drifting to 25p. 

Yet last September’s interim results helped establish a narrative of operational delivery and debt reduction. Offshore Ghana, four wells were brought on-stream, with two further scheduled. Higher production at the important Jubilee oilfield should be sustained by infill drilling, and the partners have identified further opportunities across this resource – to the end of this decade. 

Full-year 2023 working interest production averaged 63,000 barrels of oil equivalent per day (boepd), which beat September’s guidance for 58,000-60,000 after the first half achieved 53,500. Start-up of the Jubilee South East field will have helped, enabling the Jubilee field alone to surpass 100,000. After some $250 million this last year - weighted 60% towards Jubilee - five further Jubilee wells are targeted to come onstream in 2024.  

The Jubilee field is a partnership with Kosmos Energy Ltd (NYSE:KOS) and Occidental Petroleum Corp (NYSE:OXY), each of them owning 18%, but with Tullow the main owner just shy of 50% and Ghana’s state oil company with around 10%.    

Mind, this ramp up in production appears also to substitute for a decline of “Ten” field production (Ghana’s second-largest and deepwater oil project) albeit said to be “minimised”. But the sheer scale of production momentum under way at Jubilee seems key to the investment rationale here. That in turn implies some project-specific risk given its importance to Tullow’s production profile. 

The 2024 outlook is for production to average 62,000-68,000 boepd, including around 7,000 of gas. 

Peak interest rates should be a tailwind 

I am not among optimists thinking rates will fall again soon. Indeed, this may have set up near-term disappointment in stock markets. But while they could stay high for longer, the overall trajectory looks next to be downwards. 

The update cites $1.6 billion net debt at end-2023 after a $250 million reduction during the year (this debt originating from financing the “Ten” project). Guidance for end-2024 is sub-$1.4 billion, helped by $600 million free cash flow, they tout for the next two years. While some 60% of forecast sales volumes are currently hedged at $58 oil, these contracts expire in June. 

It means still-onerous finance costs. The interim results showed a $135 million interim net finance charge swipe 47% of operating profit, albeit mitigated by a $65 million gain on a bond buyback.  

But with the debt load being reduced and long-term interest rates set to edge down also, a forward PE multiple sub-2x could be said to price it in – overly so. 

As for medium-term debt risks, a new $400 million debt facility has been agreed with Glencore (LSE:GLEN), meaning no material uncovered debt maturities until May 2026. The equity is thus not exposed to repayment fears like hit Petrofac Ltd (LSE:PFC) oilfield services, making it London’s most-shorted stock.  

Yet a sense that interest rates are due a steady decline from their inflation-busting agenda, and Tullow showing a landing path to more appropriate gearing, ought to reward buyers on a two-year view. 

You could, of course, say that I am effectively repeating what I said two years or so ago, over which time the stock has mostly proven a dog. 

But in such situations, one has to consider if the original reasons for favouring upside still apply; and yes they do, operationally. The dilemma has been a spike in interest rates.    

So, I appreciate why Roald Goethe continues to overweight Tullow equity, as if contradicting portfolio management rules. He likely believes he understands the West African project economics well enough and wants to exploit still-weak sentiment. 

For those who appreciate inherent risks in oil & gas, and African political risk: Buy.  

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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