Of the 53 FTSE companies currently rated by Morningstar equity analysts, just one is boasting a 5-star rating, meaning the market is significantly undervaluing the stock.
Morningstar analysts use a free cash-flow model to value company shares. We then compare this valuation with the current market price to assign the stock a star rating. One star implies the stock is significantly overvalued by the market, i.e. expensive, five stars implies the stock is significantly undervalued, i.e. cheap. A 3-star rating implies the stock is fairly valued.
Independent oil & gas production and exploration firm Tullow Oil (TLW) currently has a 5-star rating and is the only UK-listed stock under Morningstar coverage to hold this rating. The share price has fallen 8% so far in 2014, mostly on the back of 2013 results and operational update announced in February. But Morningstar analyst Stephen Simko says Tullow Oil’s story is still intact despite the recent news of a dry drilling hole.
Shares in Tullow have lost a whopping 36% in the past 12 months. Simko says this decline implies that the market believes the firm's exploration programme will create less value than it has in the past. If this is incorrect, the stock could be trading well below its intrinsic value.
Simko values Tullow at 1,300p per share—significantly higher than the 780p price at which it trades at the time of writing.
Morningstar’s consensus of UK-based brokers’ forecasts points to the stock as a buy.
Among the risks associated with an investment in Tullow are a prolonged drop in oil prices and the lack of diversity in the firm’s operations. Tullow’s eggs are split between three baskets—Ghana, Uganda and Kenya, where political stability and country risk are serious concerns.
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