I started investing in Tullow a few weeks ago. As far as I can tell they have a fundamentally good business and have farmed down a couple of assets to balance the books. I like what I have seen so far. I was averaged in at 34p and have just raised that to 36p this morning by topping up at 44p. As expected by the market (based on the rise in the last week) it was good to see the announcement this morning that the reserves based lending facility of $1.7bn has been given the nod by the banks. There will be some dotting of i's and crossing of t's to do and it represents a reduction in Tullow's "overdraft" from $1.8bn to reflect the capital needs of the company.
Tullow has long been a highly leveraged company, but has developed a strong business underneath. For example net debt was $4.8bn in 2016, and has regularly been reduced each year through $3.5, $3.1, $2.8 and most recently year end '20 net debt of $2.4bn. The company has used the lean times of '20 to trim down and deliver sustainable cash savings of over $125m a year.
With a sensible eye on the future before the start of the pandemonium last year, Tullow hedged in some guarantees for selling its oil. As a result whilst the oil price averaged $41.96 last year, Tullow realised an average price of $50.8 per barrel for its sales. The hedging work doubled expected gross profit for the full year '20 to $400m and was worth $200m. I'm looking forward to hearing the full results for the year on 10th March.
So, it's been a difficult year for all of us, and Tullow have taken a couple of knocks, but seem resilient so far. What's the outlook for the future?
Well, according to slide 5 of this presentation the plan is to deliver $7bn of cash flow over nine years from operating activities, before debt service, capital investment and decommissioning expenditure. With an $11 per barrel average cost of production and greater than 80% internal rate of return on investment portfolio, you can see how they might execute on that plan.
There is an objective to reduce net debt by a further $900m to $1.4bn and get it into the range of $1bn to $1.5bn. The company has made a good start on that in '21 with a further $180m of cash to be received in H1 '21 with the sale to Panoro.
When valuing an oil and gas company broadly speaking you can value the proven and probable resources in the ground at $1-$3 a barrel or look at the speed with which it can be produced and sold. Tullow seem to have lots of options with different assets in their portfolio of varying maturity to realise capital according to their plan, or as they said this morning "deliver in excess of US$1 billion of self-help over two years". So the capital markets are playing nicely now, but the company is also dipping into its own pipeline to create capital to pay down the debt.
With a resurgent Brent oil price of $65.9 as I write, it seems to be a good time to re-tune the business. Most of Tullow's plans are based on an oil price of $50. The proof of the pudding will be in the rebalancing of the debt to equity ratio over time. Currently with a marcap of £619m at 43p a share or $867m and net debt of $2,220m there's a ratio of 2.56. If the company can execute on its plan and bring net debt into the $1bn to $1.5bn range, I can see the equity recovering and the ratio heading towards what CFO's tend to aim for which is a ratio of about 1. Who knows, perhaps Tullow have their sights set on a more conservative ratio of less than 1.
I own shares in Tullow Oil, this is not investment advice. Please do your own research. I'm happy to share mine.
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