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Has the Tullow Oil share price recovered too much to be a bargain anymore?

I have said it before, but I am always on the lookout for a large sell-off in the stock market, as often (perhaps even usually) it offers an opportunity. When Tullow Oil (LSE: TLW) saw its share price drop as much as 70% last week, it naturally caught my interest.

Though I thought then there was perhaps an overreaction in the sell-off, and suspected there was some quick money to be made if I wanted, I also thought that in the long term there are perhaps now more risks for Tullow than a simple production cut alone would suggest. And here at The Motley fool, we are always thinking long term.

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Even a dead cat bounces

I was of course right about the short-term recovery. As I write this, Tullow shares are back up to about 60p – far from the 141p of 10 days ago, course, but if you had invested some money at its sell-off low of about 40p, today you would be up 50%.

For those unfamiliar with the phrase ‘a dead cat bounce’, it describes occasions when a share price plummets but then manages to recover a little ground, eventually giving up these gains again as fundamentally it is still not a sound investment. I am not sure yet if Tullow’s shares are in the midst of such an action, but there is potential.

I have no doubts that bargain hunters have helped drive the price higher this past week. Looking at the shares today, which are down about 6% on the day, I suspect this dip-buying may now be at an end. There has been a quick buck to be made for sure, but as a long-term investment, I think Tullow’s prospects leave something to be desired.

Future at risk

The implications of its expected production cuts could be far broader than a simple loss of money. The lack of free cash flow could cause problems in a multitude of areas.

The company has already suspended its dividend, and with less money coming in, this looks unlikely to change for a year or so now. More importantly however, the company is going to have less money for new ventures, capital expenditure and making the most of its current assets.

Many of Tullow’s oil wells – instigated in the era of £100/bbl crude – are only profitable with a higher oil price that just isn’t there today. Just last month, the company said two of its fields in Guyana contained heavy oil, making it “difficult to commercialise”.

The company currently has £900m outstanding in convertible bonds, £300m of which is due to mature in 2021. My colleague Rupert Hargreaves thinks this is far enough away for repayments not to be an issue yet, but I am not sure I agree. As we head into the New Year, 2021 is starting to feel a lot closer to me.

This latest sell-off presumably almost guarantees no one will be converting their bonds to equity, so at least dilution shouldn’t be a problem. That said, the company has already refused to rule-out a rights issue or the selling of assets, which for me adds even more risk to the shares.

I think there was some quick money to be made last week, but for me Tullow’s long-term prospects just look too risky at the moment.

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Karl has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.