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Tullow Oil - Ugandan deal approved

Nicholas Hyett, Equity Analyst | 22 October 2020 | A A A
Tullow Oil - Ugandan deal approved

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Tullow Oil plc Ordinary 10p

Sell: 59.22 | Buy: 59.32 | Change 1.18 (2.02%)
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On 21 October Tullow confirmed that its $575m farm-down deal with Total had been approved by the Ugandan government.

The deal relates to Tullow's Ugandan oil & gas assets, and will see Tullow receive $500m up front, $75m when the final investment decision is taken and potentially additional payments linked to the oil price after production commences. Total will take over operatorship of the assets.

Tullow shares rose 23.5% on the day of the announcement.

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Our View

Approval of the Ugandan deal is a rare glimmer of good news for Tullow after a run of pretty awful luck.

The group has generally done a pretty good job of discovering and developing new assets, and after a pretty hairy time back in 2015/16 felt secure enough to start paying a dividend.

Enter a series of disappointing exploratory wells, the delay to the Uganda farm-down deal in Uganda and finally an almighty oil price crash. Instead of a steady flow of dividends Tullow is back to cutting costs left, right and centre to preserve cash and keep debt under control.

However, the drive for greater efficiency has come at a price, with some pretty brutal cuts to capital expenditure. Under-investing for a sustained period risks damaging the business's long term prospects.

Tullow has a few points in its favour. Production forecasts appear to have stabilised, and the group is well hedged over the next year or so - which should help it secure an above market price for its oil. The cash inflow from the sale of the Ugandan assets is also a positive. The project has been problematic for some time, and the proceeds will provide a useful boost to the balance sheet at a crucial moment.

Unfortunately the group is still facing some difficult conversations with its creditors, and risks going insolvent if these don't pan out. Management seems to think lenders will be understanding and relax some of the current agreements. However, there's no guarantee the group will clear all the upcoming hurdles, and failure to do so could push the group into insolvency.

While the oil price is moving in the right direction, it started from a very low base and that means life will continue to be a challenge for Tullow. The high fixed cost base and significant debt pile has always made the group a bit of a play on the oil price. If things pan out in its favour the share price could recover nicely, but with the stock trading on just 0.4 times book value, the market's clearly pessimistic and we suspect it has good reason to be.

Tullow Oil key facts

  • Price/Book ratio: 0.4
  • 10 year average Price/Book ratio: 2.4
  • Prospective dividend yield (next 12 months): 0%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results (09/09/20)

Tullow's first half revenue fell to $731m from $872m in 2019. Production averaged 77,700 barrels a day (2019: 86,300), and the group realised an average oil price of $51.8 per barrel (2019: $64.3).

Tullow has revised its long term oil price value down from $65 a barrel to $60. As a result Tullow recorded $1.4bn in impairment charges and exploration write-offs. This drove Tullow to a $1.3bn loss after tax, compared with a $103m profit last year, while the group also reported negative free cash flow, rising net debt and a decline in liquidity.

Ghana was not adversely affected by COVID-19 during the first half, producing on average 54,000 barrels a day. The TEN field averaged 24,000 barrels a day (net), and the Jubilee field averaged 30,000 (net). Management attributes this performance to increased gas offtake nominations, temporarily increased flaring and higher than expected uptime. Full year forecasts are for an average of 53,000 barrels a day in Ghana.

Equatorial Guinea and Gabon produced 5,000 and 16,800 barrels a day respectively, although full year production is expected to drop slightly in both regions. CÔte d'Ivoire produced 1,900 barrels a day but this is expected to rise to average 2,100 over the full year.

Reflecting the strong performance in Ghana and the OPEC+ quotas, full year production guidance has been narrowed to 73,000 -77,000 barrels a day. 60% of 2020 sales revenue has been hedged with a floor of $57 a barrel and 48% of 2021 sales revenue has been hedged with a floor of $51 a barrel.

Tullow and its partners have withdrawn their Force Majeure notices in Kenya after the COVID-19 situation improved and the government promised that tax incentives will continue to apply. The Kenyan government has also agreed to extend the group's exploration licence.

The $575m sale of the Ugandan assets is expected to complete before the end of year-end. Despite having been approved by shareholders, the transaction remains subject to the Government of Uganda finding a tax agreement.

Tullow finished the half with net debt of $3.0bn, up from $2.8bn at the end of 2019. The group suffered a free cash outflow of $212.5m, but expects to break even over the full year.

Under management's base case, the group is expected to breach its agreements with lenders on 31 December 2020 and 30 June 2021. Management will request a waiver or amendment to its agreements, and expects this to be granted as it was in June this year.

However, if Tullow fails to reach new agreements with lenders, if the Ugandan sale falls through, or if it is unable to raise new funding it would be at "significant risk" of insolvency. Such a scenario, in the view of the directors, "would likely result in limited or no value being returned to shareholders".

CEO Rahul Dhir said "we have been developing new plans for our business, with the support of our Joint Venture Partners and expert advisors. These plans will deliver enhanced value from our assets to benefit all our stakeholders including our host countries and investors."

Find out more about Tullow shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.