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The Tullow Oil share price rose over 20% yesterday! Should I buy right now?

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Tullow Oil (LSE:TLW) has endured a difficult 2020. The firm has been hampered on multiple levels. In different trading updates, production output forecasts have been cut, with free cash flow being reduced as well. The knock-on impact of this was a dividend cut, which saw income investors disappointed. The net result was that the Tullow Oil share price has slid lower for much of the past 12 months. From trading around 60p at the beginning of the year, it now sits around the 20p mark.

The share price received a kick higher yesterday of over 20% thanks to some good news regarding approval of the sale of a project in Uganda. But is this a fundamental shift that warrants an investment?

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What’s the latest news?

It’s been well known that Tullow has been struggling with cash flow and liquidity in general. At mid-year, liquidity stood at $500m. This may sound like a lot of money, but remember that net debt stands at $3bn. So there is a clear need to boost cash flow. News yesterday came through that Tullow would receive $575m from Total from the sale of that project in Uganda. This has been known about for a while, but the important approval from the government (which had been held up due to tax disputes) finally came through.

This news was the major reason why the Tullow Oil share price rallied so much yesterday. Unfortunately, I’m left scratching my head at this boost and don’t think the rally is sustainable. It’s a short-term positive, and does help Tullow obtain much-needed liquidity for the business. Yet the size of the debt pool simply dwarfs this inflow, making it a longer-term headache.

Add to this the downgrades in the oil price forecast, meaning that Tullow will likely receive less revenue going forward. The firm reduced oil forecasts by $5 per barrel, taking on an impairment charge of $1.4bn. So here we have debt rising and revenue potentially decreasing, not a good mix for a share price rally.

Is the Tullow Oil share price a contrarian buy?

The only reason I would consider buying the stock now is as a contrarian buy based on a cheap valuation. The price-to-book ratio sits at just 0.4. If the ratio was 1, this would mean the book value (similar to net asset value) is the same as the value from the share price. With the ratio below 1, it means investors think the firm is worth less than the book value it has. Having a ratio of 0.4 shows investors are pessimistic about the value of the assets Tullow owns, and the outlook for the firm in general.

On the flipside, it does make the stock fundamentally cheap, if you believe the book value is correct. If you were to buy the stock for the long term and optimism around the firm came back, the price-to-book ratio could easily come back to a value of 1. The Tullow Oil share price would likely have increased for this to happen.

For the moment, I’m steering clear of investing in Tullow Oil, having been burnt in the past. Instead, I’d look for depressed share prices that I think offer good value right now, such as Lloyds Banking Group.

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jonathansmith1 owns shares in Lloyds Banking Group. The Motley Fool UK has recommended Lloyds Banking Group. 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.

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