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Why I think the Tullow Oil share price looks cheap after falling 75%

The last time I covered the Tullow Oil (LSE: TLW) share price was back in December. The company had just announced its production targets for 2020, which were worse than expected. As a result, shares in the oil producer crashed by more than 75%.

Following this clanger, the company’s investors would have been hoping for some good news to ring in 2020. Unfortunately, Tullow disappointed its shareholders once more earlier this week. 

The company, which was once lauded for its exploration success, announced on Thursday that it had struck oil at its Carapa-1 exploration well off the coast of Ghana. However, the results were worse than expected. Net pay and reservoir development figures were worse than pre-drill estimates.

This new disaster has once again spooked investors. The stock moved sharply lower after Tullow published these disappointing findings. The fact management has had to issue a disappointing exploration update on the first trading day of 2020 doesn’t bode well for the rest of the year. 

Nevertheless, while it may look like Tullow is struggling at first glance, I continue to believe the stock offers value at current levels.

Value at current levels

Disappointing exploration and production results are all part-and-parcel all of the oil and gas industry. Unfortunately, this has been the norm for Tullow over the past few months. But I think it’s a mistake to concentrate on its failures.

The company might now be expecting lower production in 2020 than was previously projected. However, even at these lower forecasts, production is still expected to come in between 70,000 to 80,000 barrels of oil per day. That’s a lot of black gold. What’s more, management is anticipating output of 70,000 barrels per day on average for the following three years.

At this rate of production, Tullow is targeting a free cash flow of $150m in 2020, after capital spending. In my opinion, this cash inflow gives the company plenty of headroom to fix its problems. For example, the firm doesn’t face any debt maturities until 2021, so it’s unlikely the business will go bankrupt for at least the next two years.

Offers value

With this being the case, I think the stock offers value at current levels. While Tullow may no longer be the high-flying oil business it was a few years ago, from a valuation perspective, the stock now looks a lot more attractive. 

Based on management’s cash flow forecasts for 2020, shares in Tullow are currently trading at a price to free cash flow ratio of 7.7, compared to the oil and gas industry average of nine. Excluding unprofitable businesses, the industry average free cash flow multiple rises to the double digits. As such, now could be a good time for value-seeking investors to buy a slice of the business at a discount price.

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Rupert Hargreaves owns no share 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.