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--> After falling by half over the past two years, Tullow's shares finally look ready to rally. They could jump from a recent £8.40 to more than £10.50.

Tullow: The Best Oil Company You Never Heard Of

After years of successes, its new-well success rate fell, as did its shares. Better results could lift shares 25%.

Two years ago, Tullow Oil made a major discovery in East Africa, highlighting its position at the forefront of one of the few remaining underexplored onshore regions of the world. But even as Tullow's reserves have gushed higher, its share price has sunk. The stock (ticker: TLW.UK) has been cut in half in the past two years. By some estimates, it now trades at a 35% discount to the value of its assets.

Little known in the U.S., Tullow is an oil and gas exploration-and-production company with an exemplary track record. Reserves, at 1.4 billion barrels of oil and equivalents, have nearly tripled in the past seven years. But the $13.1 billion (market value) company's discoveries have been overshadowed recently by some high-profile drilling disappointments and worries about the costs a major development project in Ghana.

Those concerns appear misplaced. If the company can bring on partners to the Ghanaian oil fields and extend its long-term winning streak on discoveries—and there's reason to believe it can achieve both goals this year—its shares could rise 25% or more.

Tullow's results tend to be bumpy, fluctuating with exploration successes and failures and as proceeds from asset sales vary. Next year, the London-based company is expected to earn $415 million, or 44 cents a share, on revenue of $2.56 billion. (Though it's traded on the London Stock Exchange, Tullow reports financial results in dollars.) That's down from 70 cents a share in 2012, but up from last year's trough of 19 cents. The company expects to increase reserves by 200 million barrels a year, on average, in the near term. The stock yields 1.6%.

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CEO Aidan Heavey, right, says the company can afford to take big risks. Photo: Jonathan Player/Redux

TULLOW WAS FOUNDED IN 1985 in the Irish town of Tullow, about 35 miles south of Dublin, by Aidan Heavey, a former accountant and financial controller at Irish airline Aer Lingus Group. After hearing from a friend at the World Bank about some oil fields in Senegal that had been abandoned by the oil majors, Heavey decided—with no prior experience in the industry—to give it a go. Tullow now operates in 24 countries, though its production is principally in Africa.

After four years of exceptional results, in which Tullow's success rate at drilling new wells ranged between 74% and 87%, the company hit a rough patch in 2013, when its success rate on new wells fell to 65%. Investors latched on to the disappointments, but Heavey, now 61 and still at the company's helm, says that's just part of the business. "What we try to do is mix the portfolio in such a way that you can take big risks, you can drill a dry hole, but still find enough oil to make money," he adds.

Heavey began to transform the company in the early 2000s, embarking on a spree of acquisitions that included producing assets in the North Sea, as well as Uganda, Mauritania, and Tanzania.

The all-or-nothing nature of the exploration business makes for a volatile stock. After hitting a high of 16 pounds ($26.88) two years ago, the shares fell in half, to £7.49, last month. They closed on Friday at £8.40, or about 30 times forecasted 2014 earnings and 33 times projected 2015 earnings. That looks rich, but some analysts put the value of Tullow's assets as high as £14 a share, based on $100 a barrel of oil. (Brent recently fetched $110 a barrel.) A consensus of analysts has an average price target of £10.48 on the stock, 25% higher than its current quote.

BMO Capital Markets oil analyst Brendan Warn puts the value of Tullow's assets at £12.64 a share. The stock traded at a premium to its net asset value until the beginning of the recent downward move, and hasn't traded at a discount since 2008. "It's just an unlucky run of unsuccessful exploration wells," says Warn, adding that Tullow is a fantastic company with a strong balance sheet.

Tullow's net debt at the end of 2013 was $1.9 billion; it has credit lines of $2.4 billion, and this month it raised $650 million in a bond issue. Still, fears that the company may have to shoulder almost half of the $4.9 billion estimated development cost of Ghana's Tweneboa-Enyenra-Ntomme fields have weighed on the shares. Tullow has a 47.5% stake in the project; it's looking to reduce that to 30%, though right now, buyers are scarce.

Seeking to allay those worries, Heavey says that the firm is in discussion with a number of companies interested in buying a stake in the project. "We are well-funded and will wait for the right approach but we are hoping to finalize a deal this year," he says. Current partners in other projects include Anadarko Petroleum (APC), France's Total (TOT), and China's state-owned Cnooc (CEO).

Speculation in recent weeks that Tullow could be a takeover target helped lift the shares from their recent low. Reports named China's state-owned Sinochem and Norway's Statoil (STO) as potential acquirers, with bids as high as £15 a share.

Investors won't need a deal for the stock to prosper. Once new partners are brought in to develop the Ghana project, Tullow, which holds licenses to explore hundreds of thousands of square miles in Africa, Europe, and Latin America, can focus squarely on what it does best: finding new oil.

European earnings forecasts still founder

For the fourth year in a row, consensus expectations for European companies’ earnings growth at the beginning of the year have proved wildly over-optimistic. In the last four weeks, consensus earnings forecasts for Peugeot, Rémy Cointreau and Air France-KLM have all been downgraded, by 40 per cent, 11 per cent and 8 per cent, respectively, according to Bloomberg. The downgrades shed light not just on the inaccuracy of analysts’ forecasts but also on the pressures that are continuing to affect European companies’ profitability. "2014 has started in an eerily similar fashion to the last three: analysts start off the year with 8 to 15 per cent earnings per share expectations, and it ends up at -6 per cent to 1 per cent. Not great," said Nick Nelson, European equity strategist at UBS. Thomson Reuters’ IBES consensus forecasts for European earnings growth in 2014 have moved from 13 per cent at the start of the year to 8 per cent. This mirrors trends in the previous three years, where analysts also reduced their performance expectations sharply over the calendar year. "Earnings revisions for 2014 have been consistently negative," wrote Goldman Sachs’ equity strategy team in a report this week. Despite stock markets having risen significantly – the FTSE Eurofirst is up 11 per cent over the past year – there is still little sign of improving macroeconomic fundamentals in Europe feeding through to companies’ bottom lines. "One of the big concerns investors have is that the market has gone up a lot and yet we are still seeing earnings downgrades," said Graham Secker, head of pan-European equity strategy at Morgan Stanley. A strong euro, wobbles in the emerging markets from Turkey to South Africa, a US swathed in snow, not to mention rising geopolitical tension between Russia and the west over Ukraine all provided reasons for gloom during the first quarter of 2014. But investors should nevertheless take with a pinch of salt the number of companies reporting that they have "beaten" expectations, given that these have fallen so sharply over the quarter. Even so, just over half the 101 companies of the 374 Stoxx600 European companies that have reported so far on their first quarter performance have disappointed consensus earnings expectations, according to Bloomberg. The last four years are not the only examples of analysts being over-bullish. "Going back 25 years, analysts have been too optimistic about earnings growth in 20 years out of the 25 and by 8 percentage points on average over the whole period," said Mr Nelson. Mr Secker argued the demographics of the analyst community provided some explanation for the trend over recent years. "If you are an analyst working at an investment bank in Europe, if you’ve been doing this job for three years or less, you may have never seen an upgrade," he said. "Some of the junior analysts, indeed all analysts, may be underestimating operational leverage on the upside."