Tullow Oil (LSE: TLW) used to be one of London’s most touted growth stocks. In 2012, shares in the company traded as high as 1,500p thanks to investor optimism surrounding its exploration plan and production targets.
Five years on and the company is worth nearly 90% less than it was at the 2012 peak. But the critical question is, is this an opportunity to buy ahead of further growth, or should you give up on Tullow and buy its smaller peer Sound Energy (LSE: SOU) instead?
Where’s the growth gone?
Since 2012, Tullow Oil has gone into survival mode. Low oil prices have curtailed the business’s ability to pay down debt and fund exploration. As a result, the company’s capital spending is set to fall to just $300m this year, compared to the peak of $2.4bn for 2014.
Luckily, the group’s most significant capital spending obligation, its TEN project, is now complete and producing cash flow. Thanks to better than expected production from this asset, as well as its Jubilee field, net debt fell to $3.6bn at the end of October, down from $3.8bn three months before. For the full-year, management is forecasting free cash flow generation of $400m.
Tullow is making progress, but the company is still held captive by its debt. Getting that down to more acceptable levels will be management’s biggest priority in the years ahead.
Growth flexibility
Meanwhile, Sound Energy is pushing ahead with what could be a transformational project for the company in Africa.
After completing the acquisition of its interests in the Oil & Gas Investment Fund in Eastern Morocco, which it funded by placing 27% of its share capital, management believes that this prospect could be utterly “transformational for both Sound Energy and Morocco“. The latest surveys suggest these prospects could yield a best-case scenario of 8.9trn cubic feet of gas.
However, management is also warning that investors should not stake everything on success at the drill bit just yet, warning: “There can be no guarantee that its current estimates of volumes of gas originally in place will be substantiated by exploration drilling or would actually be available for extraction”.
Still, unlike Tullow, Sound has a strong balance sheet with which to pursue the development of its Morocco prospects. At the end of June, the firm reported a cash balance of $50m and debt of just under $18m, giving a net cash balance of $32m.
Flexibility
Sound is a high-risk growth play, but compared to Tullow, the group looks to me to be the better buy. With a cash-rich balance sheet, Sound has more flexibility and cannot be controlled by its creditors.
If Tullow’s creditors decide to pull the plug on the business, shareholders will be hung out to dry. So, you could argue that an investment in Tullow is, in fact, riskier than a similar investment in Sound.
All in all then, as a growth buy, I believe Sound is a better bet than Tullow.
