The hits just keep on coming for beleaguered global energy explorer and producer Talisman Energy (TSX: TLM)(NYSE: TLM). This is despite hopes that the company would be the next big turnaround story after being targeted by renowned corporate raider Carl Icahn, who now holds just over 7% of Talisman’s float.
What are the key issues facing Talisman?
Cost blow-outs and an inability to exit from uneconomic projects in the North Sea are hampering the effective turnaround of the company. For the first quarter of 2014, Talisman saw its revenue from the North Sea drop a massive 65% despite its ongoing investment in the region.
One of the biggest burdens Talisman has to carry is its 2012 commitment to invest $2.5 billion in its U.K. North Sea operations with partner China Petrochemical. This spending commitment is costing Talisman dearly and is preventing the company from allocating that capital to more productive operations elsewhere, including the much-needed production boost of crude liquids.
Such a reallocation of capital is particularly important for Talisman as the majority of its production mix is made up of lower-margin natural gas. This is hurting the company because natural gas prices continue to remain soft. Their outlook is also particularly volatile as new sources of supply come online.
With more than 60% of Talisman’s petroleum production mix made up of natural gas, the impact this is having on its profitability becomes apparent when looking at the company’s operating netback. This is a key measure of the profitability of an oil company’s production, and for the first quarter of 2014 Talisman reported an operating netback of $28.80 per barrel, well below the industry average of $46 per barrel. It’s clear that Talisman’s production is still blighted by a range of marginal operations that are not delivering solid profit margins.
Even troubled oil and natural gas producer EnCana (TSX:ECA)(NYSE:ECA), with around 87% of its total production mix composed of natural gas, is delivering a significantly superior netback of $31.64 per barrel.
Another concern is Talisman’s high ratio of net debt to cash flow of almost three times. This is despite the company embarking on an aggressive asset divestment program that has seen over $3 billion in asset sales to date, the proceeds of which have been used to repay debt.
Valuation indicators are mixed
Even after its share price plunged 12% over the last year, Talisman still does not appear to be particularly cheap on the basis of its enterprise value of eight times EBITDA. In contrast, EnCana, which is performing far more strongly and gaining greater traction with the implementation of its turnaround strategy, has an EV of seven times EBITDA. However, Talisman does appear cheap when its EV times its oil reserves and price-per-flowing-barrel of $52,000 are considered.
It is also continuing to pay a quarterly dividend, which at $0.27 annually gives it a modest yield of 2.4%. This, while not spectacular, does see existing investors rewarded for their patience as Talisman attempts to unlock value.
I certainly do not share the optimism of some industry analysts and pundits who claim Talisman now offers value. Clearly, on the basis of its vast, globally diversified oil reserves, the company offers incredible value. But until it is able to extricate itself from a range of uneconomic projects, notably its assets in the North Sea, and significantly boost crude liquids production, the company will fail to unlock value for shareholders.