The Tullow Oil (LSE: TLW) share price jumped in early deals this morning after the company swung into profit. According to its latest trading update, the West Africa-focused oil explorer posted a $93m pre-tax profit versus a $1.3bn loss the year before, even though production declined during the period.
The company benefited from a combination of factors during the first half of its financial year. Even though production fell, the realised oil price per barrel produced increased from $51.80 to $60.80.
It also benefited from a debt restructuring, which reduced group net debt from $3bn to $2.3bn. Free cash flow also increased to $86m from -$213m in the first half of 2020.
Tullow Oil share price recovery
I think these figures show that after the upheaval of the past 18 months, the company’s finally back on a stable footing. It’s generating positive free cash flow, debt’s falling, and higher oil prices are allowing the group to recoup capital investment costs.
The company believes that assuming oil prices remain above $60 a barrel for the rest of the year, it’ll earn a free cash flow of $100m. This could hit $150m if the oil price averages $70. These figures include all capital spending outlays.
Last year, the company nearly collapsed after the coronavirus-induced oil price slump hammered its balance sheet. Thanks to higher oil prices and after the debt restructuring, Tullow’s gearing level has fallen to 2.6x net debt to earnings before interest, tax, depreciation and capital spending (EBITDAX).
The Tullow Oil share price is also supported by $700m of net cash on the balance sheet. Over the next few years, management wants to reduce group gearing down to 1.5x EBITDAX.
If the company can achieve this, I think the stock will have a bright future. But there’s a lot that could go wrong between now and 2025. The oil price could fall back, and the group may face increased capital spending costs.
Unforeseen factors
These challenges exclude unforeseen factors. For example, in 2019, the organisation was focused on reducing debt and increasing output. Then the pandemic struck. The resulting carnage decimated the company’s balance sheet and forced it to write down the value of its assets by more than $1bn.
Unfortunately, it’s impossible to say if there will be another event like this in the next few years.
Still, I believe that if the oil price stays between at least $60 and $70 per barrel over the next few years, the company can meet its ambitious debt-reduction goals. That would give management headroom to reinstate the firm’s dividend, or even buy back shares.
If cash flow really jumps, Tullow could even go on the acquisition trail. By combining with another producer, the group could push down production costs and strengthen its balance sheet.
Considering this potential, I think the Tullow Oil share price has tremendous recovery potential. As such, I’d buy the stock as a speculative position for my portfolio today.
