Can Talisman Unlock its Value?

Expectations for the company are wonderfully low.

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The Motley Fool

Talisman (TSX:TLM) has been struggling with lackluster production growth, inefficient operations and a high cost profile for years. It has come to a point where expectations for the company are wonderfully low. And when expectations (and therefore valuations) are that low, it doesn’t typically take much in the way of positive news to get investors excited.

Is Talisman finally on the right track to unlocking the value in the company? Let’s look at some of the signs that point to positive change coming.

Carl Icahn pushing for change

Billionaire shareholder activist Carl Icahn is well known for taking a large enough position in troubled companies to secure a seat on the board and then swooping down on management in order to engineer big turnaround stories. He obviously believes that Talisman is undervalued, as he has taken a little more than a 7% position in the company. And back in December, he struck a deal to secure two additional seats on the board for two of his representatives in order to see to it that this value can be unlocked.

Focused capital spending, increased efficiencies, balance sheet improvements

Similar to Encana (TSX:ECA), which last year unveiled a new strategy of more focused capital spending and a renewed focus on capital efficiencies and lowering its cost structure, Talisman is also in the process of changing its strategy to one that involves a greater focus of capital spending.

Capital spending will be focused on North America and Asia Pacific. In 2013, the company sold $2.2 billion in non-core assets and it expects to generate another $2 billion from non-core asset dispositions in the next 12 to 18 months. Capital spending was reduced by 20% in 2013.

The proceeds from the dispositions are being used to strengthen the balance sheet.  Management would like to see debt in the range of 1 to 1.3 times cash flow, giving them the flexibility to increase leverage in order to take advantage of a good opportunity if and when one arises.

In another move similar to Encana, Talisman will focus its North American production on liquids rich production, as this will produce near term value and cash flow for the company. Dry gas spending decreased 30% and liquids rich spending increased 30%.

General and administrative expenses were reduced by 15% in the fourth quarter, and the company expects another 10% reduction in 2014.

Reserves

Talisman replaced 110% of its reserves this year and its Reserve Life Index (RLI) is eight years on a proven basis and 12 years on a proven plus probable basis. The reserve life index simply tells us how many years current reserves will last assuming no additions.

Challenges

Of course, the problems at Talisman are clear. The biggest one is the North Sea. The company has recorded an $826 million asset and goodwill impairment charge related to the North Sea operations. These assets are riddled with operational problems. It is a mature basin with escalating costs and it will be difficult for Talisman to resolve this situation, as the company has a commitment for future spending there based on its joint venture agreement with Sinopec, and there don’t appear to be buyers for these assets. But on a more positive note, 90% of production is from its 2 core areas, North America and Asia Pacific.

Foolish bottom line

Despite results that were below expectations and that included big impairment charges, the stock increased just over 2%. While this turnaround is still in the early stages and there is still risk associated with it, there are reasons to be warming up to the stock.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Karen Thomas owns shares of Encana and Talisman.

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