The recent volatility in the price of oil continues to weigh on investors’ minds, with shares in many companies in the industry falling in unison. Let’s look at two examples, Tullow Oil (LSE: TLW) and Hurricane Energy (LSE: HUR), and ask whether investing in either company makes sense at the current time.
Good progress
With the shares now changing hands at prices not seen since 2005, Tullow Oil’s brutal fall from grace is a perfect example of how accumulating huge debt to fund developments can comes back to haunt a company when the price of its commodity drops like a stone. That said, today’s trading update did offer a glimmer of hope for long-suffering holders of the stock.
According to Tullow, oil production has been in line with guidance during H1 with a combined average 87,000 barrels of oil per day now expected from its West African and European operations. While it can do nothing about the price of oil, the company has also taken steps to improve its precarious financial position by using cash from operations to address its significant debt burden. Back in April, the company undertook a $750m rights issue to provide it with “greater financial and operational flexibility” in the years ahead. Guidance on capital expenditure for the year has also be revised from around $0.5bn to $0.4bn. Selling its Ugandan assets will further reduce this figure to roughly $0.3bn.
These steps appear to be having the desired effect with net debt now estimated at $3.8bn — down from $4.75bn at the end of the last financial year. With unused debt facilities and free cash now totalling $1.2bn, the £2.1bn cap is making “good progress” in what are clearly difficult market conditions, according to new CEO Paul McDade.
Given the ongoing fragility of its balance sheet, the likelihood of further earnings downgrades and the fact that its stock already trades on a lofty valuation of 18 times earnings, I’m unconvinced. I firmly believe that only the most risk-tolerant of investors with sufficiently long time horizons should be considering buying Tullow’s stock at the current time.
Patience required
Since peaking at 68p in early May, shares in Hurricane Energy have almost halved. The fall in the price of black gold certainly hasn’t helped. But it would seem a significant amount of this can be attributed to concerns over how the company will accumulate the $467m needed to extract the huge volumes of oil it has located in the North Sea.
I remain optimistic on Hurricane’s prospects. It owns 100% of its assets, carries no debt and, in Dr Robert Trice, is led by a CEO who is significantly invested — both intellectually and financially — in bringing the company’s goals to fruition. News on the Final Investment Decision (FID) for the Lancaster Early Production System (EPS) is likely to drop very soon. And two more independent technical reports relating to the equally promising Halifax and Lincoln wells are expected by the end of year. I am content to maintain my holding in the company. Indeed, as activist investors appear eager in urging Hurricane’s management to consider monetising its sizeable assets, my chief concern remains the possibility of a low takeover bid being successful.
