The dividend policy being pursued by Tullow Oil (LSE: TLW) has been boggling my mind. Even with debt of $2.95bn, the company employed a “capital returns policy of intending to pay shareholders at least $100m per year.”
I thought that was plain crazy, as I generally do when a company pays out dividends while shouldering big debt – it’s effectively borrowing money to give to shareholders.
The dividend policy came to a halt on Monday, but not for the good reason that Tullow’s board had finally seen sense. No, it was down to a shock profit warning as the company slashed production guidance and suspended the dividend, and CEO Paul McDade and exploration director Angus McCoss both resigned.
Oil and gas production is now expected to fall by around 20% over the next two years, with free cash flow set to decline to around $150m in 2020, from a 2019 level of $350m. The idea of paying out $100m per year in dividends seemed ill-advised anyway, but it would be insanity to try it when cash flow is plummeting. So, no wonder the dividend has been put on hold, but right now I’d be far more concerned about the impact on Tullow’s debt repayment programme.
And I’m still puzzled by two things. One is that the firm saw fit to reintroduce dividends so soon after its debt almost brought it to its knees. And I can’t figure out how Tullow couldn’t have seen this latest catastrophe coming a little earlier.
I know the firm has been hit by unprecedented production problems this year at its TEN and Jubilee oil fields in Ghana, but those things happen in oil exploration, and I think a company in that business should focus on getting its balance sheet as defensive as possible.
I think the Tullow board has served shareholders badly this year, and the departure of McDade and McCoss is probably an appropriate response. But where does that leave us now?
Tullow came too close to going bust during the oil price crash, and that spectre is surely looming on the horizon once again. At the halfway point at 30 June, Tullow reported gearing of 1.8 times. Six months prior to that, gearing stood at 1.9 times, and a year prior it was up at 2 times. So it’s been coming down, but only at a glacial pace – and that was at previous cash flow levels. At least the company has no near-term debt maturities, so that might provide a bit of breathing space.
Now that cash flow is set to be severely reduced, I really can see gearing heading back in the wrong direction again. My Motley Fool colleague Roland Head suggests that Tullow could be forced into a new round of fundraising, after having raised $750m in 2017’s rights issue, and I think he’s likely to be right.
Tullow Oil was slowly pulling itself out of the mire, albeit with a badly misguided (in my view) dividend policy. But the recovery has come to a sticky halt and we could see it getting sucked back in again over the next couple of years.
Tullow Oil shares? I wouldn’t go within a mile of them.