For the Patient Investor, Talisman Energy Inc Could Pay Off

Flailing Canadian oil company Talisman Energy (NYSE: TLM  ) has done nothing but disappoint investors for the last few years. But with Talisman's turnaround plan in full swing, the company's shares could prove to be a lucrative investment for patient investors.

Making good progress
Aside from the loss reported for full-year 2013, Talisman's management has made great progress restructuring the company and priming for growth during 2014. For example, the company drove North American liquids production higher by 30% during the year, while lowering drilling and completion costs. Further capital spending was cut by 20% year on year and administration costs fell by a similar amount. Talisman's management also took the precaution of booking impairment charges for a total of $946 million during 2013 against exploration and oil-producing assets, hopefully limiting the prospect of impairment losses during 2014.

Restructuring
Despite progress made during 2013, Talisman's management has remained committed to the company's turnaround as we move further into 2014. During the last few weeks Talisman announced that it had completed the sale of approximately 127,000 net acres of its Montney position in northeast British Columbia to Progress Energy Canada Ltd., a wholly owned subsidiary of Malaysia's Petronas, for $1.5 billion. Funds from this sale are earmarked for the repayment of debt. With a total debt pile of only $5.5 billion, this cash should give a much-needed boost to Talisman's balance sheet.

What's more, Talisman is planning to divest another $2 billion of assets during 2014, which will cover the majority of the company's planned $3.2 billion capex for the year. Cash flow was approximately $2 billion during 2013, and Talisman's management expects an operating cash flow of $2.3 billion for 2014. If Talisman sticks to its capex budget, the company's free cash flow for 2014 will be in the region of $1.1 billion, the first time Talisman will have been free cash flow positive since 2008. Production has been hedged, so to some extent these cash flows are predictable.

A rocky road ahead
Unfortunately, asset sales will impair Talisman's production and hold back growth. Indeed, asset sales completed in 2013 alone hit daily oil production and oil reserves by 5% and 11% respectively.

Talisman has provided 2014 production guidance for 350,000 barrels of oil production daily, a moderate increase of 1% on 2013, although a 4% fall in production in comparison to 2012. But as part of Talisman's strategy, the company is targeting reserves that require less engineering work to get out of the ground, so over the next year management expects the company's cash margin per barrel of oil extracted to expand 6% to 11%.

Additionally, operating costs are also expected to fall 10% for the year. Production growth is expected to come from Talisman 's Asian and U.S. fields where output is expected to rise 4% to 7% during 2014, with liquids volume growing 14% to 19%. That being said, as mentioned above Talisman should report positive free cash flow for the first time in several years for full-year 2014 if production forecasts are met.

Pulling out of complicated projects is a strategy that oil industry leader Chevron (NYSE: CVX  ) is also following. Chevron is seeking to reduce its involvement in expensive "megaprojects," pulling out of those that seem expensive, instead favoring projects with more bang for the buck -- quality not quantity. "Belt-tightening" is another phrase being used repeatedly by Chevron's management as they seek to boost company performance. Instead the company is focusing on high-output, high-margin projects such as the Jack/St Malo and Big Foot deepwater oilfields in the Gulf of Mexico. In total, these projects will add 500,000 barrels per day to Chevron's existing production.

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.

Icahn has an impressive record of activism recently, engineering a $25 billion deal between Forest Laboratories and Actavis PLC. Icahn's activism involving Transocean (NYSE: RIG  ) has kicked the company back to growth. But Icahn only got part of the changes he demanded at the beginning of 2013. While the board voted to replace the CEO with an Icahn-backed nominee, demands to raise the dividend to an annualized payout of $4 per share were rejected.

That said, at the beginning of this year Transocean's board put forward a proposal that the company pays a full-year $3 per share dividend in four quarterly installments throughout 2014. This proposal is still to be voted through at the AGM. At current levels the $3.00 annualized dividend payout is equal to a yield of around 7% -- a great return for shareholders.

Foolish summary
All in all, for the patient investor, Talisman could prove to be a lucrative investment. The company's management is working hard to turn things around: Debt should fall this year, cash flows should rise, and the company will be able to return to growth.

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