Africa-focused oil exploration and production (E&P) company Tullow Oil (LSE: TLW) declared its year-end net debt at $3.1bn, which works out at about £2.33bn at recent exchange rates.
By any comparison, that’s a lot of money. But to put it in perspective, it’s around 1.5 times the value of last year’s revenue, about 2.7 times the total operating cash flow achieved in 2018, and 5.9 times operating profit. When it comes to borrowings, Tullow has a lot to deal with, even after its emergency Rights Issue a couple of years back.
Debt falling, dividends rising
In fairness, the level of net debt is down almost 12% since 2017. Chief executive Paul McDade said in the recent full-year report that the company is working towards becoming “a self-funding, cash-generating business with a robust balance sheet, low-cost assets and a rigorous focus on cost and capital discipline.” He reckons Tullow’s African assets provide “a strong foundation for growth in the years ahead.”
The firm is so confident in the outlook that it announced a dividend for 2018, which will cost around £50m to service. Is that wise when carrying such a load of debt? I think that remains to be seen, but Tullow seems committed to returning cash to shareholders going forward.
For 2019 onwards, dividends will be based on the generation of free cash flow “while ensuring an appropriate balance with debt reduction and investment in the business.” And I think tying repayments to free cash flow is a good idea rather than setting some arbitrary level and then the management team feeling it has to either maintain the value of the dividend from one year to the next or increase it a bit.
Yet the directors haven’t stopped there. They seem to be positively fizzing with enthusiasm for slinging cash at investors, saying in the report that special dividends will be paid on top the ordinary dividend “in periods of particularly strong free cash flow generation.” So, if things go well, it looks like we can expect Tullow to deliver us plenty of income from our shareholdings in the company.
Changing characteristics?
Previously, many were attracted to the stock for capital growth. Between 2008 and 2012, for example, the share price rose almost 200%, driven by a surge in the price of oil. Indeed, with all its debt, Tullow has been inclined to react like a financially geared play on the oil price. But that characteristic could be set to change if Tullow makes decent progress with its debt-reduction programme.
Nevertheless, there’s no doubt that Tullow’s fortunes have been dependant on the price that oil is selling in the market. You only have to compare the firm’s share-price chart with a chart for oil to see that.
However, I reckon there’s a chance that future moves in Tullow’s share price may not be as dramatic as they have been in the past. Maybe the ongoing appeal of the share will be its dividend rather than its potential to deliver capital growth. If that proves to be the case, I’d ask myself the question, do I want my dividend-led investments to be backed by firms with a highly cyclical business such as Tullow Oil? And the answer to that is, no.
