It's been an interesting week for investors in Tullow Oil. If you're new to the company you might like to check out this introduction with links to various information. Also by way of introduction is to be open about those intrepid investors who have borrowed shares in Tullow hoping that they will go down or that they can sink the company and be the reaper of great rewards. I've put together some information about the borrowers and there's a site that summarises their short of a few quid positions. This information is normally updated each working day by about 6.30pm and provides tremendous entertainment to long term holders who actually own the shares. Joking aside, with a low oil price last year, high net debt of $2.4bn and a general pandemonium Tullow was distressed.
In my humble opinion any logic for that distress is now looking so 2020, and as things start to return to normal we should see the logical relationship between the average Brent oil price and average Tullow share price return. Here are some thoughts and a view of what that gap looks like.
Why do we buy shares? Bit obvs that one, but I would suggest it's to make money. We might sell our shares if oil goes down a few cents or dollars hoping that we can buy back more shares next week. I think we've all probably tried that and sometimes it works, sometimes it doesn't. I would suggest that it certainly increases the amount of time we spend watching the share price. I'd also propose that there is one clear advantage of the long term hold. If you've bravely bought at 34p or 44p or 54p (because every time we buy we think it's at the peak and it may go down), over time if the share price goes up, your average buy price fades into the distance, you feel calmer and if it goes up 3p it's worth a lot more to the 34p person. I know it's all obvious but it's probably a battle we all face from time to time.
Anyway, what's next for Tullow, and back to that question of why do we buy shares if we're just going to keep them and get on with our day job. We want the company to make some money. Tullow reports free cash flow as a figure "before capital investment, decommissioning expenditure and debt service". Here's a quote from this January RNS
Underlying operating cash flow is expected to be c.$0.5 billion at $50/bbl for the first year of Tullow's new business plan which aims to deliver c.$7 billion underlying operating cash flow over the next 10 years; 2021 pre-financing cash flow is expected to be c.$0.2 billion at $50/bbl
I thought I would model that into a spreadsheet and play around with different levels of production in '21. They are predicted to be in the range 60,000 to 66,000 bopd. There is some simple maths to do a reduction from 74,900 bopd in '20 followed by an increase from the realised oil price of $50.8 in '20. This is back of the fag packet stuff, but it gives an idea of what FCF might be before $365m of planned Capex and decommissioning in '21. I've then divided that into the marcap of £718m which was correct as I started to write this. The exchange rate I'm using is 1.39
So what might the valuation of Tullow be?
I've put a black border around one potential return on investment that you might get for buying Tullow shares at 50p. As Tullow and the oil price carry a fair amount of risk, let's say you're looking for a 20% return. i.e. you want the marcap to be no more than 5 times the net FCF figure. I calculate this to be a share price of £1.23. If you're happy with a 10% return of free cash before debt repayments then this would be £2.45 a share.If you think the green border is a potential reality for '21 which production in the middle of forecast and an average OP of $70 which has got to be a bit of a stretch for the year, then at a 20% return I make the valuation £1.52 a share.
I hope that's been interesting and you're enjoying your time investing in Tullow. Remember to do your own research and don't get FOMO if you've sold your shares. I own shares in Tullow Oil and this is not investment advice.
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