At first glance, Tullow Oil (LSE: TLW) seems like the perfect stock to play a rebound in oil prices. The company used to be one of the London market’s most successful oil explorers but over the past few years as the price of oil slumped, the company fell by the wayside. Some setbacks have cost the company hundreds of millions of dollars in writedowns, and debt has risen as the group’s TEN development takes place.
Debt issues
Unfortunately, the development of TEN, which is expected to revolutionise Tullow’s production profile, has put the company’s balance sheet under an enormous amount of strain. At the end of June 2016, Tullow’s net debt was estimated at $4.7bn and unused debt capacity and free cash at approximately $1bn. Including derivative positions, being used to hedge the price of oil, Tullow’s net debt is around $5.2bn. When the TEN project is running at full steam, management believes that the company will be generating enough free cash flow to begin to pay down debt at a healthy clip. But the company will always be at the mercy of oil prices and the debt mountain overhanging the group leaves management with little room for manoeuvre if things don’t go to plan.
Tullow is a highly leveraged play on oil prices, which may not be suitable for everyone. BHP Billiton (LSE: BLT) on the other hand may offer the same exposure with less risk.
Same exposure with less risk
BHP is a more significant player in the oil industry than Tullow. The company is targeting production of between 200m and 210m barrels of oil and gas production for its 2017 financial year. That’s approximately 575,000 barrels of oil equivalent per day (Tullow was targeting production of 100,000 boe per day this year but is expected to miss this objective due to maintenance issues). What’s more, the company has stated that it’s well-placed to ramp up oil production from its North American shale oil wells if the price of oil rises above $50-$60/bbl.
Further, unlike Tullow, BHP isn’t a one trick pony. The company has interests across the commodity spectrum. Coal, iron ore, copper, and oil are the company’s four main areas of focus, giving the firm a diversified portfolio of production assets. Along with its diversification, BHP’s size makes it a much more attractive prospect than Tullow. For example, for the year ending 30 June 2016 BHP reported underlying EBITDA of $12.3bn and an underlying EBITDA margin of 41% even though weaker commodity prices lopped some $10.7bn off earnings.
A handsome EBITDA margin of 41% in a weak environment is a result of the company’s cost-cutting efforts. Free cash flow for the period came in at $3.4bn, compared to Tullow’s minus-$500m cash outflow from operations during the six months to June 30.
Overall, if you’re looking for one company to play the oil price recovery diversified, cash rich BHP may be a better bet than highly leveraged, struggling, Tullow.
