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Tullow Oil - Full year production guidance cut

Nicholas Hyett | 24 July 2019 | A A A
Tullow Oil - Full year production guidance cut

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Tullow Oil plc Ordinary 10p

Sell: 43.19 | Buy: 43.44 | Change -3.67 (-7.79%)
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Tullow reported revenues of $872m in the first half, a touch below previous guidance, with gross profits of $527m, a touch above. Technical problems encountered while drilling on the TEN Ghanaian oil field have led Tullow to reduce production guidance for the full year.

The board announced an interim dividend of 2.35 cents per share.

The shares were broadly flat following the announcement.

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Our View

More technical problems in Tullow's Ghanaian oil fields. It's been a recurring theme, and given that between them the TEN and Jubilee fields account for around 70% of Tullow's production is far from ideal. Unfortunately that's one of the risks with smaller oil companies. The fortunes of key assets will, to a great extent, determine share price performance.

Still, for those prepared to take a longer term view we think there's a lot of good things going on at Tullow. Management are confident the group can both pay a dividend and shift the debt that's been the monkey on Tullow's back.

The group's locked in prices of over $56 a barrel for a significant portion of its anticipated production in the next two years, and the rest should fetch more given the market price is some way above that at the moment. On top of that production is set to rise, and operating costs have dropped to just $10 per barrel.

But there is such a thing as over-confidence.

Already the tailwind of a rising oil price is flagging and the aforementioned technical problems mean production isn't rising as fast as expected. Combine that with borrowing that's still a little higher than we'd like and the company's still uncomfortably exposed to a reversal in oil prices.

Tullow also needs to replace existing reserves. The group probably spent less on exploration and development than it would like over the last few years, while it fought to keep its head above water. So we're not surprised to see the group increasing investment in new projects.

Progress in the East African portfolio, which includes development projects in Kenya and Uganda, has been mixed. While the Kenya project is going well - with a final investment decision expected next year, it's less positive in Uganda. An agreement with the Ugandan government on a farm-down deal with French and Chinese partners has stalled and Tullow is considering other options to sell its stake.

Given the struggle in Uganda, all eyes are turning to the millions of dollars' worth of exploration assets in Guyana, Argentina, Cote d'Ivoire and Peru. These early stage assets are speculative but have the potential to generate significant upside - and Tullow has a reassuringly good track record with the drill bit.

Nonetheless, Ghana will remain the driving force behind profits for some years yet, with cash flows from the West African fields underpinning a target to pay at least $100m a year in dividends. That suggests shareholders could be in line for a 3.5% yield going forwards, perhaps more if all goes well. Investors should remember there are no guarantees though, especially with the group's success closely tied to the ups and downs of the oil price.

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Half Year Results

First half production averaged 89,000 barrels of oil equivalent per day (boepd), including production-equivalent insurance payments. Full year production is now expected to average 89,000-93,000 boepd, down from 90,000-98,000 expected in June.

Revenue was 3.6% below the same period last year, reflecting a lower average oil price. However Tullow also reduced underlying cash operating costs per barrel, down 17.4%, with operating profits up 29.3% as a result to $388m.

Capital expenditure during the half hit $248m (from $145m last year), with free cash flow of $181m.

The group finished the half with net debt of $2.9bn, down 4.3% on last year. However, the improvement in profitability means gearing fell from 2 times cash profits to 1.8.

The development of the group's Kenyan oil assets is said to be progressing well, with terms signed with the Kenyan government and a final investment decision targeted for the second half of 2020. The Uganda farm down continues to make limited progress.

Tullow has begun a three well exploration campaign in Guyana, and expects to have results from the first well in early August. The group has acquired new licenses in Argentina, Peru and Namibia during the half, with additional drilling opportunities in Peru and Suriname.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.