Tullow Oil is a 4 Star Stock, say Analysts

Despite the significant fall in the oil price, Tullow Oil remains undervalued according to equity analysts, and the company could be a takeover target thanks to its assets

Stephen Simko, CFA 21 November, 2014 | 9:51AM
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Although Tullow Oil (TLW) is trading well below its net asset value, a plausible argument exists that there is good reason for this: Tullow's future free cash flow burn means it must eventually monetize assets, and in today's oil price environment, that means this will probably transpire at depressed prices. The negative funding outlook is driven by Tullow's interests in major oil discoveries being developed that will require far more capital than any company of its size can possibly generate from its operations. Forecasting 2015-17 cash flows at current strip prices, Tullow is set to spend $2.6 billion more than it will generate during this period.

While its portfolio of growth projects would begin to generate significant free cash flow when completed at the end of the decade, the cash burn in the interim is enough to materially stress the balance sheet. At some point between now and 2017 at the latest, Tullow will have to sell at least partial stakes in a couple of its major assets. And as of late 2014, the recent oil price decline has materially weakened the oil and gas M&A market. As of today, there appears to be a decent chance that any oil company forced to sell assets to shore up its balance sheet in the coming months could be forced to take a material discount.

Positively, Tullow completed multiple financing transactions before oil prices fell that will provide a great deal of financial support. Entering 2015, the firm will have approximately $2.3 billion of borrowing capacity from its existing credit facilities. Further, its debt is all longer term (the earliest maturity is December 2017) and has only one light covenant (net debt/adjusted EBITDA must stay below 3.5 times).

Based on current oil futures, Tullow's funding situation should allow it to avoid violating the 3.5 times threshold even if it doesn't sell assets. Further, the company would not run through its available borrowing capacity until 2017. The intelligent financing decisions thus will allow the firm to withstand a lot of financial pressure and wait for decent offers for its assets in the M&A market.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Tullow Oil PLC28.92 GBX-2.63

About Author

Stephen Simko, CFA  is a senior stock analyst at Morningstar.

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