Elevator Pitch #5: I Can See Your Talo, Talo, Talo
Oil producer possibly at an inflection point.
Talos Energy (TALO) is an offshore E&P with producing assets in the Gulf of Mexico. These assets have proven reserves of 194 million barrels of oil equivalent (MMBoe) with a PV-10 value of US$4.4 billion. Forecasted production of roughly 93 thousand barrels per day (Mboe/d) implies a reserve life index of 5.7 years. Their hedging program allows them to be cash generative in 2025 with crude prices as low as US$40.
Talos has a history of making questionable acquisitions, frequently involving the issuance of equity. In 2020, they closed an acquisition of assets in the Gulf of Mexico, which led to the issuance of 11 million new shares. Later that same year, they closed another transaction, resulting in the issuance of 4.95 million shares. To complete the 2020 dilution hat-trick, they announced a public offering of more than 8 million shares, using the funds to pay down debt and for general corporate purposes. In 2022, Talos completed the acquisition of EnVen Energy, resulting in the issuance of 43.8 million shares. Two years later, in 2024, Talos bought QuarterNorth Energy, issuing 24.4 million shares to QuarterNorth shareholders. These transactions involved debt issuance as well, but I want to focus on the dilution as debt has never reached unsustainable levels. Shares outstanding have multiplied. The company ended 2019 with 54,204,730 shares outstanding. At the end of Q1 2025, shares outstanding had increased to 178,455,146. I realize that up until this point this pitch reads like a short thesis, but change might be coming.
One swallow does not a summer make
On the 17th of June, Talos held an investor presentation to announce an enhanced corporate strategy. This included groundbreaking objectives like “improve our business every day “.
One of the takeaways from the presentation was their focus on integrating previous acquisitions. Talos believes this will add US$100M to free cash flow in 2026. I’ll be surprised if they reach half that, but at least they are focused on the right thing. Additionally, they want to change their portfolio to longer-lived assets which wouldn’t be a bad thing considering the current short reserve life. This will be done with bolt-on acquisitions, which I am fine with as long as these are debt financed. Most importantly, they communicated a capital return policy where they’ll aim to return up to 50% of free cash flow to shareholders.
In Q1 of this year, Talos reported adjusted free cash flow of US$195M. When I make my own adjustments, this free cash flow figure is closer to US$140M. Annualize this to get US$560M. For a company with a current market cap of US$1.55B, this means that if Talos indeed spends 50% of free cash flow on buybacks, it could reduce share count by roughly 18% per year. This is back-of-the-napkin math, but it illustrates the potential for significant capital returns. Especially considering there are no near-term debt maturities, and net debt/ebitda stands at only 0.8X. This is below the company’s target of 1.0X.
Why should management be believed when they don't have a history of competent capital allocation? They shouldn’t until they show they mean what they say. But two things make me think that this time might be different. Firstly, a new CEO was appointed in March who wasn’t involved with previous acquisitions and secondly, they have actually started buying back shares. Share count went down from Q4 2024 to Q1 2025 by almost 1%. This is not nearly as aggressive as I would like, but it is a start. When they report Q2 figures and they have not meaningfully stepped up the buyback, it shows they are not serious about capital returns and the stock is a hard pass.
Disclosure: No position