The Tullow Oil (LSE: TLW) share price is falling today and is down by 15% as I write. This slump seems to have been triggered by the Africa-focused oil producer’s annual results. These showed that sales fell last year and that Tullow generated an $81m loss in 2021.
Oil prices are soaring and most of the big oil producers on the London market have reported bumper numbers for 2021. I’d guess that investors might have been expecting a stronger result from Tullow. In this article, I’ll explain what’s happened, and why I’m not buying Tullow shares.
Here’s the story
Tullow’s revenue fell by 9% to $1,273m in 2021. Although the company’s average oil sale price rose from $51 to almost $63 per barrel last year, Tullow’s production fell sharply due to technical issues on the TEN and Espoir projects.
These problems combined with the write-off of some past exploration costs to generate an after-tax loss of $81m for the year.
However, oil producers’ reported profits can be very different to their cash flows. For this reason, I prefer to focus on Tullow’s cash generation and debt repayments. The company continued to make good progress in these areas last year. Free cash flow of $245m was used to repay borrowings, cutting the group’s net debt from $2,376m to $2,131m.
Will profits fly in 2022?
The price of oil has risen by more than 50% to around $125 per barrel so far this year. Should we expect Tullow’s profits to soar if prices stay high? Will shareholders get a dividend?
I think the group’s accounting profits could rise, but a dividend is very unlikely. To understand Tullow’s position today, it’s important to remember that the company ran into big problems with debt a few years ago.
CEO Rahul Dhir has stabilised the business and debt is now falling. However, to provide more predictable cash flows, Tullow has hedged 75% of its production until May 2023, and 50% to May 2024.
This means the company has entered into contracts that provide guaranteed minimum and maximum sale prices for most of its oil.
Hedging protected Tullow from a cash crunch in 2020. But it also means that the firm isn’t getting the full benefit of high prices today. As a result, management guidance for 2022 is based on an average oil price of $75 per barrel, 40% below the current Brent Crude price.
Tullow Oil share price: cheap at 55p?
Broker forecasts for 2022 suggest that Tullow will generate earnings of $0.16 per share this year. That puts the stock on a modest five times forecast earnings.
However, while profits are expected to rise, management expects Tullow’s free cash flow to fall from $245m to $100m in 2022. This is due to a 35% increase in planned spending on projects and decommissioning.
This guidance prices Tullow shares on around 10 times forecast free cash flow. That seems high enough to me. Although I don’t expect Tullow to face any serious problems this year, I’d prefer to invest in a company with a stronger financial position.
I don’t think Tullow Oil shares are as cheap as they might seem. For this reason, I won’t be adding this stock to my portfolio at the current price.
