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RBC downgrades Tullow Oil as it sees difficulties in potential upsides

Published: 19:37 01 May 2018 AEST

Tullow Oil worker
RBC worried cost saving measures may have been an overcorrection

Canadian bank RBC has downgraded FTSE 250-oiler Tullow Oil PLC (LON:TLW) to Sector Perform from Outperform as it saw the company struggling for additional upsides to its shares following a boost from high oil prices.

Analysts at the bank said the surge in Brent crude prices and the expectation of stronger cash flows had lifted the shares to its price target of around 230p, however it saw the only potential upside following this as adding new reserves to the stockpile.

READ: Tullow Oil says it is on-track to hit production target

Analysts at RBC said: “Upside from here probably requires the derisking of the company’s (2C) contingent resources; but with the market polarised – rewarding producers and penalising explorers - Tullow needs to encourage investors to recognise the value of 2C resources.”

They added: “We expect Tullow to focus initially on the addition of higher value reserves in its producing fields, including Jubilee and TEN, and it is likely to enjoy a boost in Equatorial Guinea. Thereafter the delivery of the Lake Albert development in Uganda and the confirmation of resources in Kenya are key.”

Worries of overcorrection from cost saving measures

The bank questioned whether previous debt reduction and cost saving measures had dented the company’s earning prospects, saying: “Management’s 2017-H1/18 priority was debt reduction, and with continued spending cuts, the deferral of Tullow’s debt repayments and the oil price surge, debt is now less of a concern.

“But having sold down in Uganda and issued new shares in H1/17, we wonder if Tullow has overcorrected - measured on a per share basis reserves and resources have fallen to a 13-year low.”

RBC also queried Tullow’s stomach for another African acquisition: “Given the cost and time senior management spent completing its last major deal – the acquisition of Heritage Oil’s Uganda portfolio – the idea of acquiring Kenya partner Africa Oil may prove unpalatable; however, if the Lokichar Basin project is as attractive as the management team hopes, an all-paper deal would tick a lot of boxes.”

However, the bank said the potential value of the company’s Lokichar Basin was not being acknowledged by potential share buyers: “At $430m the market appears to be allocating no value to the company’s ~20% stake in the Lokichar Basin. Unlike Uganda, we envisage no CGT issues, and unlike TEN the development costs are not front-end weighted, especially if the pipeline costs can be reassigned. And, in the event that any offer is trumped, at least Tullow would have re-rated an unwelcome bellwether.”

The downgrade follows a first quarter trading update last week, where Tullow told investors it was in line to meet production guidance with net oil production of around 87,700 barrels of oil per day.

In mid-morning trading Tuesday, Tullow shares were down 1% at 225.4p.

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