To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.
To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.
Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.
So this series aims to identify appealing FTSE 100 investment opportunities and today I’m looking at Tullow Oil (LSE: TLW), the oil and gas exploration & production company.
With the shares at 1,053p, Tullow’s market cap. is £9,602 million.
This table summarises the firm’s recent financial record:
| Year to December | 2008 | 2009 | 2010 | 2011 | 2012 |
|---|---|---|---|---|---|
| Revenue ($m) | 1,012 | 916 | 1,090 | 2,304 | 2,344 |
| Net cash from operations ($m) | 747 | 277 | 732 | 1,731 | 1,520 |
| Adjusted earnings per share (cents) | 45.15 | 3.2 | 8.1 | 72.5 | 68.8 |
| Dividend per share (cents) | 8.78 | 6 | 6 | 18.66 | 19.51 |
Revenues and profits from oil and gas production are rarely the whole story when it comes to placing a value on oil and gas explorers like Tullow. Over recent years, the firm has been extraordinarily successful with its exploration drilling around the world and now owns around 1,211 million barrels of oil equivalent (mmboe) of oil and gas reserves, a figure that includes both its commercial (developed) and contingent (yet to be developed) resources. Those assets have value, and it’s that value that traditionally underpins an oil company’s share price.
But as well as resources in the ground, valuation sums are likely to include the potential for asset upgrades thanks to future drilling success. Expectations for Tullow, with its hitherto golden drill bit, are likely to be high. Indeed, the firm has drilled 13 exploration wells and 14 appraisal wells so far this year, which have achieved an overall 63% success ratio. That’s impressive. With plans for a further 20 wells before the end of the year, the chances of further asset increases are high. Meanwhile, the share price is around 35% down from the peak it reached during 2012.
Tullow is performing well strategically and operationally, and at this level, I’m optimistic about its total-return prospects.
Tullow’s total-return potential
Let’s examine five indicators to help judge the quality of the company’s total-return potential:
1. Dividend cover: adjusted earnings covered last year’s dividend around 3.5 times. 5/5
2. Borrowings: net debt is around 1.5 times the level of operating profit.4/5
3. Growth: cash flow provides firm support for flat-looking earnings and growing revenue. 4/5
4. Price to earnings: a forward 26 looks beyond earnings and yield expectations. 3/5
5. Outlook: good recent trading and a positive outlook. 5/5
Overall, I score Tullow 21 out of 25, which encourages me to believe the firm has potential to out-pace the wider market’s total return, going forward.
Foolish Summary
Robust dividend cover, under-control borrowings, a strong record of growth and a positive outlook all combine to encourage me that, yes, I should invest in Tullow Oil.
There’s no doubt that Tullow Oil has been, and continues to be, a successful oil and gas exploration company, but imagine the roughly ten-fold share price gain you’d have enjoyed if you’d bought the shares ten years ago. To get those kinds of returns from oilers, realistically, you need to look at smaller exploration and production companies that have potential to grow into Ftse 100 giants like Tullow.
To help with that quest, I recommend getting your hands on a copy of The Motley Fool’s report on the best way to go about investing in smaller, or junior, oil and gas E&P companies. It’s called How to Unearth Great Oil and Gas Shares.
I recommend the methodology set out in this report to get you off on the right foot with oil companies. To get your copy while it is still free click here.
> Kevin does not own shares in Tullow Oil.