News that Tullow Oil (LSE: TLW) missed its debt reduction targets in 2018 caused the shares to wobble on Wednesday. To be honest, I was expecting worse. Investors appear to be confident in the firm’s claims that around $300m of late payments have simply been delayed, not lost.
Is this the right view, or should the market be more wary about the outlook for debt-laden Tullow?
What’s gone wrong?
Africa-focused Tullow was one of the big casualties of the 2015/16 oil market crash. The firm’s shares are still worth about 75% less than they were five years ago, thanks to a debt burden that peaked at $4.8bn in 2016.
Things are improving. In a statement today, the company said that production totalled 88,200 barrels of oil per day (bopd) in 2018, and is expected to rise to 93,000-101,000 bopd in 2019.
Net debt fell from $3.5bn to $3.1bn last year, thanks to free cash flow of $410m. However, these figures missed the guidance provided by the company in November. Back then, it said net debt would fall to $2.8bn and free cash flow would be $700m.
The main problem seems to be that the company has not yet finalised a deal to sell a share of its Ugandan oil fields to French firm Total for about $200m. The company now hopes to finalise this deal in the first quarter of 2019, but press reports suggest a potential tax dispute with the Ugandan authorities.
Buy, sell or hold?
Tullow Oil intends to pay an annual dividend of at least $100m starting from 2019. My sums indicate that this would be worth about 7.2p per share, giving a prospective yield of 3.6%.
Personally, I think it’s a little too soon to be making such generous payouts. But management seems confident it can continue to reduce debt while increasing spending on shareholder returns and new growth projects.
Tullow shares look cheap on a 2019 forecast price/earnings ratio of 9. But in my view the size of the firm’s debt pile means that this valuation is probably high enough. I’d continue to hold the shares, but I won’t be buying.
Here’s one I would buy
One oil-related stock I would like to own is engineering services firm John Wood Group (LSE: WG).
This FTSE 250 oil services business also operates in a range of other industries, such as nuclear power and renewables. However, oil and gas still account for the majority of profits.
Service companies like Wood Group are usually slower to recover after an oil market slump. This is because the firm’s customers don’t start spending again for some time after the price of oil has recovered. Tullow is a good example — three years after the price of oil started to recover, the firm is starting to invest in new projects again.
Now that customers are becoming more confident, Wood boss Robin Watson expects profits to start rising again. Analysts expect the group’s earnings to climb 19% to $0.71 per share this year. This puts the stock on a modest forecast P/E of 10.3, with a dividend yield of 4.8%.
Wood’s dividend hasn’t been cut since the firm’s flotation in 2002, and has historically been backed by strong cash flows. I’d rate this stock as a solid income buy at current levels.
