It has been a good six months for shareholders in Tullow Oil (LSE: TLW), with the share price rising 36%. That still leaves the shares a massive 83% lower than they were five years ago, however.
So, with the stock so far below where it used to be and recent momentum looking positive, should I fill my boots?
Ongoing business strength
The business continues to perform well.
Revenues in the first half slid 10% compared to the same period last year. But that was down to lower oil prices, as volumes actually increased slightly. Volatile oil prices remain as a risk (but also an opportunity) for both revenues and profits.
Indeed, I think the recent rise in the Tullow Oil share price has been largely driven by strong oil prices and the prospect of further consolidation in the sector following Exxon’s mammoth takeover of Pioneer.
The full-year outlook shared at the interim point seemed decent enough to me in most respects. The key concern I had when reading it was net debt of $1.7bn. That is around £1.4bn, roughly three times the company’s current market capitalisation.
At that time, Tullow said it was “progressing a range of options to address debt maturities and position the business for a successful refinancing”. Yesterday (13 November), it announced that it has secured a $400m five-year borrowing facility.
Concerns about debt levels
That takes the heat off the company for now when it comes to maintaining liquidity on its balance sheet.
It does not solve the underlying debt problem, though. To illustrate why that has helped drag down the share price, first half profits after tax from continuing activities were $70m. But that was after it had paid net financing costs of $135m.
In other words, (presuming an equivalent tax treatment) profits after tax would have almost tripled if the company was not spending so much on financing its activities.
What might lie in store for the valuation?
If the oil prices moves down, I think the share price could soon follow. But with some analysts predicting record oil prices on the horizon, that could be good for the company.
To get back to anything like its historic highs, though, I think the balance sheet needs to be dramatically cleaned up. Higher oil prices could help that if the company puts the proceeds into paying down debts. At a time of high interest rates, having the debt pile it does is a millstone for Tullow’s finances.
But although a higher oil price could propel Tullow Oil shares higher, the debt situation alone puts me off adding the company to my investment portfolio.
