The Tullow Oil (LSE: TLW) $790m rights issue shocked the market when it was first announced, but since the revelation at the end of March, City analysts have broadly agreed that it was the right thing for the company to do.
However, what remains to be seen is if this cash call will be enough. Indeed, even with an extra $790m Tullow’s debt remains elevated. At the end of 2016 the company reported debt of $4.8bn, after this cash call, and $900m received from the sale of one third of its Ugandan assets to French oil major Total, net debt should be in the region of $3.1bn, down a lot year-on-year but still a big obstacle to future growth.
Plenty of work to do
Tullow’s management still has plenty of work to do before the company can convince the market it is back on a stable financial footing.
Management recently started discussions with lenders concerning the group’s $3.3bn reserve-based lending facility, which the firm has been heavily reliant on in recent years. Recent actions to reduce debt should increase the likelihood of banks extending this facility, but an extension may come with some restrictions. For example, at the end of last year, Tullow had access to $1bn under a revolving credit facility, which the company has agreed to reduce to $600m by January 2018 and $400m by October 2018. If banks demand a similar reduction in headroom for the $3.3bn facility, Tullow faces an uphill struggle and may need to tap investors for more cash to meet deadlines.
That being said, after producing first oil from its Tweneboa-Enyenra-Ntomme (Ten) deepwater project in Ghana last year, the company has stated that it can generate positive free cash flow with oil trading at $50 a barrel. This means today Tullow is eking out a small positive cash flow margin on production. At the time of writing Brent crude is trading at $53 a barrel from a low of $47 printed during March.
Touch and go
Even though management statements indicate Tullow is generating a positive free cash flow with oil prices where they are today, I’m still cautious about the company’s outlook. While management has bought itself some headroom with recent actions to cut debt, banks may remove this flexibility by lowering headroom on borrowing facilities. Moreover, as we’ve seen over the past three years, the oil price is extremely volatile, and it won’t take much for oil to collapse back below $50 (in fact some analysts are still calling for oil to drop down to $20/bbl).
The bottom line
So overall, the next few months will be key for Tullow. If the company can get its banks to extend its reserve-based lending facility on the same terms as before, the outlook will be significantly improved. On the other hand, if headroom is reduced there may be a chance of another rights issue further down the road if oil prices don’t cooperate.
