The oil market may be starting to recover, but a number of popular oil stocks have been left with huge debt hangovers.
Figures released today show that Tullow Oil (LSE: TLW) now has net debt of $4.7bn nearly 50% more than its market cap of 2.6bn ($3.2bn). The situation is more extreme at Enquest (LSE: ENQ), where net debt of $1.7bn is more than five times the groups 254m market cap.
Both companies are nearing the end of big projects thatstarted just as the oil market crashed. Completing these projects has required extra debt to offset falling cash flow from oil production.
Turning the corner?
The good news is that Tullow has completed the TEN project and expects to start generating free cash flow during the final quarter of this year. Enquest expects to start producing oil from the Kraken field during the first half of 2017.
In both cases, spending should fall sharply and cash flow should rise. Debt repayments will also begin. However, recent financial updates suggest to me that if oil stays close to $50, both firms could still require extra cash next year.
Tullows shrinking overdraft
Tullow Oils lenders are starting to scale back the groups main source of borrowing, its reserve-based lend (RBL) facility. In an update today, the company confirmed that in October, the RBL was cut from $3.5bn to $3.3bn. A further reduction is expected in April.
The company expects to start repaying debt during the fourth quarter, but has also arranged a $345m extension to its RBL to largely offset the impact of the planned reduction in April 2017. This suggests that the groups management is concerned that at current oil prices, debt reduction wont be quick enough to keep pace with the firms shrinking borrowing capacity.
I dont expect Tullow to run into serious debt problems. But I think theres a risk that the shares could underperform the wider oil market if the price of oil stays flat.
After 82m placing, will Enquest need more cash?
Enquest has already raised some funds from shareholders. The group sold 82m of new shares earlier this month in order to help fund the completion of its Kraken and Scolty/Crathes projects.
None of this cash was used to repay debt. Even if it had been, 82m wouldnt have been enough to make a dent in Enquests $1,681m net debt. To help put this in context, Enquests net debt is 16times its 2017 forecast net profit of $100m.
Enquests position is more extreme than that of Tullow and I believe the shares carry a lot of risk. My view is that this months equity raise is intended to tide the firm over until Kraken production starts next year. At this point, a more comprehensive refinancing may be necessary.
Am I paranoid?
Its worth pointing out that if the price of oil rises strongly, my concerns could prove groundless. But theres no guarantee that will happen.
Whats certain is that lower levels of forward hedging mean that both firms will be more exposed to oil price movements next year than they have been so far. In my opinion, Enquest and Tullow are still too risky for equity investors. I believe there are better buys elsewhere.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
