Smaller oil and gas explorers are among the riskiest stocks I’ve invested in. Since I sold out at around the break-even point a few years ago, the Tullow Oil (LSE: TLW) share price has crumbled.
I had a lucky escape. But every time I see Tullow shares down in the dumps, I wonder if it might be time to get back in.
We’ve had a bit of an uptick so far in 2023. Since the start of the year, we’re looking at a modest 4% price rise. But the bigger picture isn’t too pretty. Over the past 12 months, Tullow Oil shares are down 33%. And over five years, the loss grows to a painful 82%.
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In an update on 25 January, chief executive Rahul Dhir spoke glowingly. He said: “Strong operational delivery, rigorous focus on costs and capital discipline, the increased equity in our key operated fields in Ghana and higher oil prices drove material, expectation-beating free cash flow generation in 2022“.
Cash flow
Expectation-beating free cash flow can be a rare thing in the oil exploration business. So that’s good to hear.
The trouble, though, is that the cash needs to be used to tackle Tullow’s debt mountain. The CEO went on to speak of “accelerating the group’s deleveraging towards a net debt to EBITDAX ratio of 1.3 times by the year-end“.
If Tullow can achieve that, it could mark an important milestone. At the first-half stage in June 2022, that net debt to EBITDAX ratio stood at 1.9 times, so there’s still some way to go. Net debt itself was $2.3bn.
Valuation
Oil share valuation is tricky at the best of times. And debt makes it harder. Forecasts put Tullow on a price-to-earnings (P/E) multiple of only around two. What we have here, though, is a company with a market cap of £566m but with net debt of $2,336m (£1,887m).
To buy the whole company and pay off its debt, an investor would need to stump up £2,453m. We can use that to calculate what’s known as an enterprise value P/E, instead of just using the market cap. Doing that, we get a P/E of around 8.6.
That still might not seem too stretching for a company sitting on Tullow’s oil and gas assets. And that’s where the temptation to buy at today’s share price comes from.
Debt progress
But for me, it all comes down to debt progress. It is coming down, after the pre-Covid year of 2019 ended with $2.8bn. But progress has been intermittent, and debt management in 2022 was helped by oil price strength.
Oil is still around $85 per barrel. But it might well come down in the next 12 months. And that could make Tullow’s debt-reduction plan that bit more difficult.
So, I do see temptation in the current Tullow share price. But as long as I’d essentially be buying part of a huge debt with a small oil company tacked on, I’ll resist.
