The Tullow Oil (LSE: TLW) share price fell by more than 50% when the stock market opened on Monday morning, after the company slashed its production guidance for 2020 and beyond.
The company’s chief executive and exploration director, Paul McDade and Angus McCoss, have both resigned with immediate effect. The dividend has been suspended.
Here, I’ll explain what’s happened, what I think it means for shareholders, and what I’d do with Tullow stock now.
What’s gone wrong?
Tullow has suffered a string of production problems this year at its TEN and Jubilee oil fields in Ghana. As a result of a review of this situation, the company has “reset” its production guidance for 2020 onwards.
Production is now expected to fall to 70,000 – 80,000 bopd in 2020. During 2021-2024, production is expected to average just 70,000 bopd each year.
Based on 2019 production guidance of 87,000 bopd (which has already been cut three times), Tullow’s new guidance suggests oil and gas production will fall by around 20% over the next two years.
Management expect free cash flow to fall to $150m in 2020, compared to $350m for 2019. As a result, the planned annual dividend of $100m has been suspended, just one year after it was announced.
What does this mean for shareholders?
I wasn’t convinced by Tullow’s plans to restart dividend payments this year. I thought the firm should have focused more heavily on debt reduction before returning any cash to shareholders.
Today’s news has strengthened my view that the group’s net debt of $2.9bn is a serious risk to shareholders. I suspect the big drop in production over the next two years will make it difficult for the company to keep up previously planned debt repayments. I’m also concerned that the company’s leverage (the ratio of net debt to profit) will rise to uncomfortable levels.
If Tullow looks like it will struggle to meet debt repayment deadlines, the firm’s lenders might decide to take control of the situation. This would be bad news for shareholders. Tullow raised $750m in a rights issue in 2017. I wouldn’t be surprised if more fundraising is needed in the next 18 months.
What I’d do
I’m a big fan of value investing. I’m happy to go against the trend and pick up shares in company’s whose assets are being undervalued by the market. But I’m always very careful where debt is concerned. The reason for this is that lenders always have ‘seniority’ over shareholders. This means if lenders need to take a loss, or provide extra cash to rescue a business, shareholders are certain to face much bigger losses.
At the moment, I see Tullow Oil as a gamble. We don’t yet know much about the company’s problems, or the impact they will have on its financial situation.
Personally, I’d sell Tullow shares after today’s news. With production falling, I think the company will have difficulty managing its debt load. I will review the situation when the next set of accounts is published. But until then, I think this is a stock to avoid.
