Those holding shares in Tullow Oil (LSE: TLW) have endured a white-knuckle ride over recent days. In case you don’t know, the stock plunged from around 208p by more than 80% between November 11 and December 9, before bouncing back up to today’s level around 60p, where it’s bobbing around. There could be further swings ahead.
Big borrowings
One of the major problems with the company is that it has a lot of debt, and big borrowings don’t mix very well with highly cyclical operations. The balance sheet in last July’s half-year results report disclosed net debt of around $3bn, yet annual operating profit has been running close to just $600m.
To put that in perspective, imagine you were running a corner shop business and you’d borrowed money to set up the operation. Then imagine that it would take your entire profit for five whole years to pay off your debts. That’s where Tullow is.
But it gets worse. Because the price of oil is so volatile and outside Tullow’s control, the company never knows whether it will be able to make enough money to service the interest payments on its debt. And there was debt-induced trouble brought on by sinking oil prices a few years back for the firm.
Operational problems
On top of that discouraging background, Tullow is wrestling with some more-immediate problems. In an update on 9 December, it announced the chief executive and the exploration director had resigned “by mutual agreement and with immediate effect.” The company is now looking for a new chief executive.
Production has been on the slide. Back in July, the directors cut their guidance on production for the full 2019 trading year to 89-93,000 Barrels of Oil per Day (bopd) because of operational problems. Then on 13 November, they cut it again, to around 87,000 bopd. After that, the statement on 9 December revealed the problems look set to endure.
The directors completed a review of the production performance issues in 2019 and their “implications for the longer-term outlook of the fields.” The conclusions were not good. The company realised it needed to “reset” its forward-looking guidance. And the bottom line is they expect 2020 production to average between 70,000 and 80,000 bopd.
The three years after that will likely only reach about 70,000 bopd – ouch! No wonder the shares have been falling.
Financial vulnerability
Tullow’s income will be lower and the firm has been looking at ways to slash costs. So it’s no surprise the recently announced dividend has been axed completely. Suddenly, the debt mountain is looking problematic. All we need now is a collapsing oil price and Tullow could find itself in deep trouble again.
There’s too much risk for today’s shareholders for my liking and not much concrete upside potential. There could be share-price gains ahead, but I think it’s a gamble for me to buy the stock.
I’d much rather invest in the market itself and, in this case, a low-cost, passive tracker fund that aims to follow the FTSE 250 index would fit the bill.
