Thinking of buying the Tullow Oil share price? Read this first

Roland Head updates his view on Tullow Oil plc (LON:TLW) and highlights another potential oil buy.

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Back in July, I explained why I thought the Tullow Oil (LSE: TLW) share price might offer seriously good value.

Today I want to highlight another reason why I believe Tullow’s shares could be too cheap to ignore. I also want to consider another oil stock which looks much riskier, but which could also deliver big gains over a fairly short period.

Poised for lift-off?

In my previous piece, I noted how Tullow’s cash operating costs are now 43% lower than they were in 2014. The group’s net debt is roughly the same as it was then, but the difference is that spending is now falling and cash flow is rising rapidly.

The group’s latest results showed free cash flow of $401m during the six months to 30 June, double the $205m generated during the first half of 2017.

I believe the figure for the second half of the year could be significantly higher, based on recent oil price gains. During the first half of the year, the price of Brent Crude remained below $70 until April. Tullow’s average oil sale price for the period was $67.50.

So far in the second half, oil has traded between about $71 and $80. So unless the price falls sharply over the next couple of months, I think it’s fair to assume that the average oil sale price for the current six-month period will be over $70.

In my view, this suggests that free cash flow for the full year should be $900m-$1bn, which should speed up debt reduction.

The firm’s shares currently trade on a 2018 forecast price/earnings ratio of 11.6, falling to a P/E of 9.2 in 2019. At this level, I rate Tullow as a buy.

An under-the-radar buy?

Shares of Africa and Asia-focused oil and gas firm Ophir Energy (LSE: OPHR) are now worth nearly 90% less than five years ago. What’s gone wrong?

The big disappointment is that the firm has so far failed to find a partner to finance the development of its Fortuna LNG gas field, off the coast of Equatorial Guinea. A previous joint venture deal collapsed during the first half when US oil services firm Schlumberger withdrew.

Time is now running short, as the firm’s licence to exploit this discovery runs out at the end of 2018. Without a financing deal before then, Ophir could lose this asset altogether.

Moving on?

In today’s results, interim chief executive Alan Booth stressed that he’s “continuing to work to deliver value for our shareholders while we are in possession of the licence”. But to be honest, I think the company is already moving on.

The firm has acquired a string of production assets in Asia, and today’s strategy update made it clear that this will be the main focus from now on.

A hidden bargain?

Ophir expects its production assets to generate free cash flow of $300m over the next three years. Averaging this to $100m per year gives the stock a price/free cash flow ratio of just 3.5, which is very cheap indeed.

Analysts’ forecasts also suggest a potential bargain. Full-year profits are expected to rise from about $19m to $61m in 2019, putting the shares on a 2019 forecast P/E of 5.6.

Although Ophir isn’t without risk, I think the shares could prove to be cheap at current levels.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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