NEW YORK (TheStreet) -- Oil producers have been focusing on preserving their financial strength in order to prepare for what could be a tough crude pricing environment next year. Even so, Canada's Talisman Energy (TLM) could struggle beyond pricing as it does not generate enough cash to meet its capital requirements.
Talisman operates in several oil and gas producing regions of Canada, South America and Asia Pacific where it has been reporting exploration success. Last week, Talisman and its Colombian partner Ecopetrol (EC - Get Report) reported their second oil find in Colombia after a gap of nearly four years.During the third quarter conference call earlier this month, Talisman's CEO Harold Kvisle said that he was "excited" about the new well results coming from the ongoing drilling activities in Alberta's Greater Edson and the Duvernay region. Prior to this, Talisman said on the backdrop of a conference in September that it was ramping up the development of its Kinabalu oilfield in Malaysia and Red Emperor project in Vietnam.
Overall, Talisman plans to grow production by 5% per year between 2013 and 2018 from its core assets. Consequently, the company forecast between 10% and 12% growth in annual cash flows from these assets in the corresponding period.
Yet, despite the optimism, crude prices have fallen by more than 20% in the last three months and Talisman is not in an ideal position to deal with this challenge.
The size of the company's long term debt of $4.7 billion is not alarming. Talisman's debt-to-equity ratio, which is often used to measure leverage, is higher than that of some of its Canadian competitors such as Penn West Petroleum (PWE) , Cenovus Energy (CVE) and Suncor Energy (SU - Get Report) , but lies within the industry's average, as per data compiled by Thomson Reuters.
The real problem is the Talisman's inability to generate positive free cash flows, thanks to higher cash outflows as capital expenditure and lower cash inflows from operations. This was also evident in the previous quarter when the company reported negative free cash flows of $407 million.
This problem is also reflected in Talisman's trailing 12-months levered free cash flow, which shows the company's ability to fund its expansion from its cash flows after payment of debt obligations, of negative $683 million. By comparison, its aforementioned competitors had positive levered free cash flows in the same period.
Talisman has been selling its non-core assets to shore up its balance sheet and offset the impact of negative free cash flows. Earlier this year, Talisman set out to sell $2 billion of assets by the middle of 2015 and this month, Kvisle said he is confident that the company will meet this target within the time frame.
However, Goldman Sachs' analyst Brian Singer wrote in a Nov. 6 report that in terms of free cash flows, things could get even more difficult next year as Talisman's struggling U.K. North Sea business could weigh on its performance.
Talisman has been looking to reduce its exposure to the North Sea by selling this business, which eats up $800 million of capital a year and still generates negative cash flows, but is having a difficult time in finding any buyers.
The company also predicted that it could reduce the value of some of North Sea assets in the next quarter. A write-down could be bad news for investors. But on a slightly positive note, management also said that it would focus on lowering negative cash flows in the future by increasing production and lowering North Sea costs.
Nonetheless, Singer is staying on the sidelines until he gets further clarity on the company's future growth and free cash flows.Talisman's shares have fallen by around 50% this year, trading in the $5.79 range today. Talisman did not respond to email and phone messages from TheStreet requesting comment.
TheStreet Ratings team rates TALISMAN ENERGY INC as a Sell with a ratings score of D+. TheStreet Ratings Team has this to say about their recommendation:
"We rate TALISMAN ENERGY INC (TLM) a SELL. This is driven by some concerns, which we believe should have a greater impact than any strengths, and could make it more difficult for investors to achieve positive results compared to most of the stocks we cover. The company's weaknesses can be seen in multiple areas, such as its disappointing return on equity, weak operating cash flow and generally disappointing historical performance in the stock itself."
You can view the full analysis from the report here: TLM Ratings Report