Tullow Oil needs to unlock value in Kenya with a farm-out – broker

Source: ProactiveInvestors

Tullow’s partner banked nearly half a billion from a farm-out earlier this year, and Numis says a similar deal could help Tullow fix its balance sheet.

Tullow Oil plc needs to do good business over its East African assets, according to City broker Numis, which sees the share going higher but is sticking to a ‘hold’ recommendation for now.

Whether or not Tullow secures farm-out deals for assets in Kenya and Uganda will be major factors in the outlook for the oil firm’s balance sheet, says Numis analyst Thomas Martin.

“We see a considerable improvement in Tullow’s balance sheet if deals can be agreed on terms similar to our modelling, indeed our analysis shows the potential for East Africa to become a source, rather than a use of cash,” he said in a note.

Africa Oil, Tullow’s partner in Kenya, has already demonstrated a possible blueprint as back in February it agreed a farm-out with Maersk which delivered some US$427mln to the Toronto listed oiler.

That deal saw Africa oil halve its interest in blocks 10BB, 13T and 10BA in Kenya – where discoveries in the Locichar basin amount to an estimated 750mln barrels of recoverable resources – and Tullow still retains its original 50% stake in the project.

But, as the portfolio currently stands the Martin doesn’t believe Tullow will have the financial wherewithal to make the most of its discovered resources.

“Whilst there is upside to our 280p/share discovered resource NAV assuming no farm-outs, developing the portfolio at current interests will exert too much pressure on the balance sheet making this unachievable,” he added.

Farm-outs, if done, can however ‘restore balance sheet resilience’ according to Martin. Longer term, meanwhile, he continues to see value-adding potential within the Tullow business.

“Tullow retains an enviable exploration opportunity set and the recent industry hiatus provides an opportunity for low cost technical work to be completed to refresh the prospect inventory.

“Future exploration programs are likely to be more targeted with fewer wells, aiming for a higher chance of success. The reduction in industry costs enables higher levels of activity for a given level of investment.”

He notes that exploration drilling is scheduled to restart soon in Kenya, and Tullow is also expected to drill a high impact well offshore Suriname during 2017.

A four-well exploration programme is due to start in the Lokichar basin during December, and Tullow said last week that it was targeting an ‘early oil pilot scheme’ to come on stream (producing some 2,000 bopd, which would be trucked to market) by mid-2017 whilst planning for a full field development continues.

Meanwhile the company at the same time told investors that good progress was being made on upstream dev elopement in Uganda, where production licences have been awarded and front end engineering and design (FEED) contracts are expected to be dished out in the New Year.

Numis rates Tullow as ‘hold’ and has today increased its target price to 260p per share.

The broker highlights that Tullow is ‘extremely’ leveraged to the crude oil price, noting that a US$10 increase in long term oil prices (from US$60 to US$70 per barrel) would see the broker’s value jump 70% up to 321p.

That said, Numis also sees a ‘premium rating’ for Tullow’s shares and comparatively the broker prefers Nostrum Oil & Gas and Genel Energy PLC  which it says have greater upside to their valuations.

The upside for Cairn Energy Plc and Soco International Plc are similar to Tullow Oil, the broker added.

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