Do its recent interim results finally constitute a turning point for this mid-cap firm?
Its stock is around the low point of a terrific roller coaster.
Two decades ago, it soared from about 60p to test £13 by early 2012 amid progress in and further hopes for exploration offshore West Africa. It then slumped below 150p over three years due to disappointments conflating with oil price volatility and debt.
Despite exploration vigour, Tullow Oil (LSE:TLW) let itself become the victim of a fashion investment bankers used to promote as “optimal balance sheet structure”.
You would think directors of risky exploration and production companies had more sense than to load up with colossal debt – despite low interest rates are low – when geared to inherently volatile commodities.
Yet this is how Tullow, also Premier Oil (PMO), very nearly went bust, and those responsible were replaced.
So, key upshot from the results is a reduction in the 30 June net debt level from $3.0 billion (£2.2 billion) to $2.3 billion. Mind that Tullow has $267 million negative net assets, which puts its stock off-limits to investors requiring a margin of safety.
New executive chair was an earlier trigger to pay attention
In recent years, I have thought it best to avoid the stock but explained in December 2019 how existing holders could take heart, its new executive chair stood a good chance of managing through various challenges.
Given Tullow has an interesting asset base to work with then at 67p a “hold” stance could be justified.
The onset of Covid-19 dealt a force majeure where the oil price slump to an 18-year low around $20 a barrel added to Tullow’s balance sheet strains – culminating in a $1 billion write-down last year.
In anticipation, the stock was marked as low as 15p in March 2020. This summer it has traded over 60p – helped by oil’s rebound – though in the last two months traded down to about 40p.This probably relates more to questions whether Covid is being beaten than a verdict on oil company management.
The stock jumped to 48p in early response to Wednesday’s results, which in chart terms looks more like mean reversion than a break-out. It has already slipped back to 45p but I would not read much into that, Tullow will always be volatile until its debt comes down significantly further.
Mind that the executive chair went non-executive and is to stand down – having essentially helped transition the company – also the chief financial officer is to step down. Investors will need to assess the calibre of replacements.
Three key reasons why the risk/reward profile is becoming favourable
First, oil prices’ strong recovery over $70 a barrel has greatly improved the company’s chances of working down its debt – potentially to a dividend-paying position, might even be responsible say on a five-year view.
Management says that if oil prices stay over $60 a barrel this year, it will achieve free cash flow (i.e. after capital expenditure) of $100 million – or potentially $150 million if oil prices average $70. Periodic asset sales, like is the convention for dynamic exploration companies, can also help reduce debt.
A plunge in oil would hit market sentiment but Tullow has a comprehensive hedging programme and scope to cut capital expenditure if it fell below $55.
Second, last springtime saw a debt refinancing - such that no maturities exist until 2025 - which mitigates a key downside risk to equity value.
The latest results’ “going concern” statement for the period up to 30 September 2022, cites a base case of $60 oil and a low case of $45 a barrel. At last June-end, Tullow had around $700 million unused debt capacity and free cash.
Third, the operations narrative is improving within a framework of a 10-year business plan. The West African producing assets are performing well, holding more than three billion barrels of oil equivalent in place, with production at the upper end of guidance.
Drilling has started in Ghana and a revised development plan for Kenya holds potential for a farm-out – where a larger partner takes a stake – which could be high-impact for Tullow’s value.
This would help trigger the classic modus operandi of a vigorous explorer, where cash proceeds are re-invested in other potential high-impact projects.
The 2021-2025 period plan has been further refined, with self-funded $1.3 to $1.5 billion capital expenditure – requiring no additional debt.
It intends to grow production and reserves also continue to reduce gearing – where $179 million interim finance costs compared with $370 million operating profit.
Tullow Oil: financial summary
Year end 31 Dec
|reporting in US$||2015||2016||2017||2018||2019||2020|
|Turnover ($ million)||1,607||1,360||1,885||2,048||1,725||1,396|
|Operating margin (%)||-68.1||-55.5||1.2||25.8||-80.3||-72.9|
|Operating profit ($m)||-1094||-755||22.4||528||-1,385||-1,018|
|Net profit ($m)||-1035||-600||-176||84.8||-1694||-1,221|
|Reported EPS (cents)||-96.7||-56.0||-13.7||5.9||-121||-86.6|
|Normalised EPS (cents)||-17.0||8.9||21.7||19.2||-26.6||-26.3|
|Op cash flow/share (cents)||91.4||47.9||95.1||83.7||89.8||49.5|
|Free cash flow/share (cents)||-71.2||-48.4||71.2||53.1||52.6||19.0|
|Dividend per share ($)||0.0||0.0||0.0||4.8||0.0||0.0|
|Covered by earnings (x)||1.2|
|Net debt ($m)||3,982||4725||4,868||4,452||4,208||3,582|
|Net asset value ($m)||3,155||2,230||2,706||2,893||984||-210|
|Net assets/share (cents)||295||208||195||208||69.9||-14.9|
Source: historic company REFS and company accounts
Higher oil prices offset slightly lower production
First-half working interest production fell 21% to average 61,230 barrels a day, however the realised oil price was 17% higher at $60.8 a barrel and so revenue was broadly flat at $727 million.
A $93 million net profit near-equates to $86 million free cash flow after $101 million investment compared with a $213 million like-for-like outflow.
The essentials still flag a company in transition where numbers have plenty to prove. Normally, the market moves to discount prospects and Tullow’s narrative is certainly promising; but it involves a chequered history and so investors are likely to be wary. So, expect the stock to show bursts of excitement, also drops, for a while yet.
Oil prices are probably the key variable
Deciding whether to hold Tullow, indeed any other oil & gas-related stocks, assumes taking a view on energy prices.
Gas is soaring, which implicitly is supportive for oil given the two commodities often co-exist in the ground.
If inflation becomes ingrained (which looks to be the case as wage increases spread), then commodities will increasingly be seen as a hedge, with traders liable to hoard: it is hard to imagine crude oil escaping what appears a nascent trend.
On the fear side however, oil’s extent of rebound from 2020 lows was helped by tight markets after inventories – also exploration/production – were cut back in response to the pandemic, then colossal monetary/fiscal stimulus boosted demand.
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Traders see little evidence the global economy is overall escaping Covid constraints, hence inventories being key to follow.
There is also a headwind for sentiment, where institutions are nowadays liable to be divesting fossil fuel-related stocks – similarly as tobacco – amid a welter of environmental, social, and governance (ESG) stipulations.
Yet this will reach equilibrium and despite all the emphasis on alternative energy the world is likely to remain a substantial consumer of oil & gas for decades to come.
Accumulate the stock for high risk-return
Despite these macro uncertainties and still high debt, as a company analyst I respect the turnaround evolving here – with capital upside from major projects, plus a 10-year development perspective.
Unless oil prices substantially de-rate again, and stay there, then overall the risk/reward profile favours upside – and recovery from current levels could be sharp, into a 100p to 200p range on a multi-year view.
For investors who appreciate and can stomach the risks, I therefore think Tullow merits starting to accumulate – and at very least, deserves following closer. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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