Last week, shares in Tullow Oil (LSE: TLW) plunged after the company cut its production outlook.
Shares in the oil producer slumped by as much as 75% on Monday, following its announcement that production will be almost a third lower than management had been expecting.
At the beginning of this year, management declared that production would hit 100,000 barrels of oil equivalent a day in 2020. It is now expected to be just 70,000 bbl/d.
An unmitigated disaster
Following this warning, it is now clear that 2019 has been an unmitigated disaster for Tullow.
At the end of 2018, the group was riding high as oil prices stabilised and its exploration activity yielded better than expected results. At a capital markets day in 2018, Tullow told investors that its fields in Ghana could potentially produce as much as 200,000 b/d of oil, and it even reinstated its dividend towards the end of the year.
However, in 2019, the group has faced one gut punch after another. It has been unable to squeeze oil out of its Ugandan discoveries, voiced doubts about the commercial viability of the crude it found off the coast of Guyana in South America, and warned on production from its flagship Ghanaian assets.
All of these setbacks have knocked investor confidence. Tullow was once highly respected for its success at the wellhead, but this reputation now lies in tatters.
The recent guidance cut, coupled with the failure to sell a $900m stake in a Ugandan project, has made it clear that the firm is no longer the oil market darling that it once was.
Value investment?
The good news is, as long as there are no further setbacks, Tullow thinks it can produce free cash flow of $150m next year. What’s more, the company does not face any debt maturities until 2021, which gives it plenty of time to fix the operational issues before borrowing becomes a problem.
And that’s why I think now could be an excellent time to buy shares in Tullow. To me, it looks as if the recent sell-off has been overdone. The company is still producing cash and is not at risk of bankruptcy any time soon.
From a valuation perspective, using management’s adjusted free cash flow figures for 2020, the stock is currently trading at a price-to-free-cash-flow ratio of 5.8 and a free cash flow yield of 17%.
These metrics look attractive compared to sector peers. Take oil major BP, for example. This oil giant is currently dealing at a free cash flow ratio of 16 and a free cash flow yield of 4.9%.
That being said, BP does not have the balance sheet issues and reputational problems that have enveloped Tullow over the past 24 months.
Still, I think this comparison illustrates clearly how cheap the stock is after the recent decline. So, if you have a strong stomach, it could be worth buying the Tullow share price today, although I should caution that this is only suitable for the most risk-tolerant of investors.