valuation of petroleum exploration and production companies · valuation of petroleum exploration...
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Valuation of Petroleum Exploration and Production Companies
SGX Auditorium
10th January 2013
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Peter Cockcroft ([email protected])
Petroleum Exploration & Production (E&P) Overview
• E&P firms represent the “upstream” aspect of the energy industry. Pipeline and marketing firms are known as “midstream” companies, and refiners and petrochemical companies are considered “downstream” participants.
• The primary assets of an E&P company are its oil and gas reserves, that is, hydrocarbons below the surface that have not yet been produced and are economically viable to extract. E&P firms are unique in that their primary asset base is depleting and therefore must be continually replaced through either drilling activities or acquisition.
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E & P Activities
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Risk
SGX E & P Companies
Company Country Exploration Appraisal Develop Production
Interra (ITRR)
Indo, Myanmar
Loyz (LOYZ) US, India, Aust, NZ
Mirach (MENR)
Indo, cambodia
Ramba (RMBA)
Indo
RH Petrogas (RHP)
Indo, China, Myanmar
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SGX Oilfield Service Companies
• Atlantic Navigation (Cat) • Ausgroup • CH Offshore • Chuan Hup Holdings • CIVMEC • Ezion Holdings • Ezra Holdings • Falcon Energy • Gaylin Holdings • IEV Holdings (Cat) • Jaya Holdings
• Jason Marine Group (Cat) • Jasper Investments • Kreuz Holdings • KS Energy • KTL Global • Mermaid Maritime • Nordic Group • SBI Offshore • Swiber Holdings • Swissco Holdings (Cat)
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Different sectors require different valuation metrics
Preferred metrics include return on equity (ROE), earnings per share (EPS), dividend per share (DPS), book value per share (BVPS), and gearing.
• ROE is calculated as net income divided by the shareholder's equity. It measures a company's profit by revealing how much a company generates with the money shareholders have invested.
• EPS is net profit before tax divided by the number of shares on issue.
• Book value is assets less liabilities and tells you the equity contributed by shareholders
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For Banks the focus is on return on equity, earnings per share and dividends per share
With Healthcare companies the focus is on return on equity and book value per share
– The former is the key to evaluating most companies and works similarly for most stocks. A higher ROE generally leads to a better company. Companies that are able to grow BVPS through retaining earnings and then deliver high ROE the next year are desirable companies (at the right price) ndustrials
For Industrials, gearing and shares are on issue are a focus, along with other metrics. A high gearing level should be avoided. A company with high gearing can cause financial risk at a time when its share earnings are under pressure
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With Property stocks Yield is a key focus. If there is no rental return it becomes much more difficult to value the property. Rentals are the key return element.
– Net tangible assets is the underlying valuation of the property expressed as a per share number. This could be considered the face value of a listed property security and is important in assessing the premium or discount when purchasing.
With Infrastructure cash flow per share is the focus as it is less affected by the accounting treatment. Yield is also an important global valuation metric infrastructure. Gearing is also a key metric. Large capital requirements mean it is important to know how they are funded.
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BUT……………
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E and P is Different
• The gross margin is high
• Chance of success is low
• Field Oil and gas inventory declines from first production
• Oil price is dominant variable
• Very few customers
• Cooperative – not competitive
• Joint ventures are the norm
• Compete against Nature 10/1/2013 10
• Largest assets are off Balance Sheet
• It is big business
• EP companies outsource most services
• Employ few people
• Not much union influence
• It is an international business
• Government interaction is routine
• Nationalization is a threat
Typical Valuation Approaches and Methodology
• E&P companies are commodity businesses which have no control over the prices they receive.
• They may vary their production and capital expenditures based on current and future price expectations and can hedge their reserves by utilizing the futures market.
• The primary method we use to value E&P firms is the Market Approach because of the availability of reliable pricing and operating data.
• We do not typically use the Income Approach directly
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The different flavors of Oil
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E and P Metrics
Just what are these criteria? E&P analysts use several yardsticks to determine if a company’s shares are worth buying. In the main, they pay attention most to these factors:
• A producer’s present and potential cash flow per share;
• Total capitalization or total enterprise value/EBITDA (earnings before interest, taxes, depreciation and amortization);
• Full-cycle return on investment • Share price versus a company’s breakup value or appraised net worth • Finding and Development costs
The managements of E&P companies aren’t being judged by the market on their ability to generate net income, but rather on their ability to take the cash they generate from production and invest it in existing or new properties to improve the underlying asset value of their companies
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• When valuing E&P companies, an analyst may focus on total enterprise value/EBITDAX (earnings before interest, taxes, depreciation, amortization and exploration expenses).
• It is a debt-adjusted ratio that takes into account a company’s unlevered cash flow - a useful equalizer in comparative valuation analysis in that it eliminates the effect of varying high- to-low-debt capital structures on cash flow
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• This valuation yardstick, can be an eye-opener for investors. Here’s a hypothetical example:
• Alpha Oil Co. and Beta Oil Co. both have EBITDA of $10 million. But while Alpha has $100 million of equity and no debt, giving it a total capitalization of $100 million, Beta has $100 million of equity and $100 million of debt, giving it a total EV of $200 million. Thus, the total cap/EBITDA multiple for Alpha is only 10 while the same multiple for Beta is 20.
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• Breakup or NAV analysis: If an investor can buy a producer’s reserves in the stock market for less than what an independent engineering report says they’re worth, then there’s an opportunity to make money as those reserves are produced and sold in future years. – If the net present value of a producer’s future oil and
gas cash stream—plus the value of its other assets less debt—is $1 per share, and that company’s stock currently trades at 50 cents per share, then we have discovered a stock that’s selling for half its breakup value
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AN E&P BALANCE SHEET GLOSSARY
Cash flow Annual net income (after-tax earnings) plus depreciation, depletion and amortization (DD&A), deferred taxes and other non-cash charges.
Cash flow per share Annual net income plus DD&A and other non-cash charges divided by number of common shares outstanding.
Cash flow multiple Stock price divided by annual cash flow per share.
Break-up value Also called liquidation or appraised net asset value. Represents the estimated net asset value of a company, assuming that all tangible assets, liabilities and preferred stock were liquidated.
Break-up value per share The estimated net asset value accruing t o a company’s common shareholders, assuming all tangible assets, liabilities and preferred stock were liquidated.
Discount to break-up value The percentage of discount that a company ’s common shares trade at relative to that company’s estimated break-up value per share.
Finding costs The costs incurred to find and develop oil and gas reserves, exclusive of lifting, operating and G&A costs.
Full -cycle return on investment Cash flow per equivalent barrel divided by multi- year average finding costs.
Total enterprise value Also referred to as total capitalization, it is the value of common equity plus long-term debt plus preferred stock.
EBITDA Earnings before interest, taxes, depreciation and amortization.
EBITDAX Earnings b e f o r e interest, taxes, depreciation and amortization, and exploration expenses.
Total enterprise value to EBITDA Also called total capitalization/EBITDA. It is equity plus long-term debt and preferred stock divided by EBITDA. This ratio allows a company’s cash flow t o b e viewed o n a debt - adjusted basis , thereby taking into account the impact of financial leverage on that company ’s price/cash-flow multiple.
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What are the risks?
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Risk ≠ Uncertainty
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• Risks are those factors which could influence the achievement of business objectives. This definition includes both the 'upside' opportunity and the 'downside' hazard.
• It is important to identify, assess and determine appropriate ways of responding to upside risks in pursuit of opportunity and value. It is also important to identify, assess and determine appropriate ways of responding to downside risks which could hinder performance or result in losses.
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Exploration Risk
– They may be looking in the wrong place
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Geological Risk
– The Geological Interpretation may be wrong
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Contract Risk
– The lawyers did a bad job
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Government Risk
– The fiscal terms may be changed
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Graffiti in Buenos Aires on Monday said that the Spanish owner of the oil company YPF, Repsol, should “get out of YPF.”
Political Risk
–War
–Nationalisation
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Development Risk
– The engineers get it wrong
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Natural Risk
– The “hundred year” wave
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Terrorist Risk
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Environment Risk
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Operational Risk
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Corporate Risk
– Their stock suffers, or they are subject to a takeover bid
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Commercial Risk
10/1/2013 32 2004 Oil price movements
48.44
46.11
35.73 35.66 34.27
42.33
48.70
42.12
55.17
30
35
40
45
50
55
60 ($/bbl)
June 1
June 29
Oct. 22 & 26
Apr 21
August 19
Al-qaida's
threat to US
presidential
election
131OPEC
Conference
(+ 2.5 million b/d) Growing
concerns
toYukos
oil
production
Halt of Iraq oil
export from
north
Decrease of
U.S. crude oil
Saudi Oil Minister's
announcment to
increase production
capacities
(to 11 millionb/d)
132OPEC
Conf.
( + 1million
b/d)
Nigerian
General
Strike
President Bush’s
re-election
Recovery of Mexican Gulf
production, increase of
US crude oil inventory,
slow down of Chinese
economy
Winter
Supply
concerns
Fears of
possible
terror in US
Decrease of
US heating
oil inventory
Halt of
Iraq oil
export
Concerns
for
Hurricane in
Mexican
Gulf
growing
concern to
Yukos oil
production
Sadr agreed
to withdrow
its forces
from Najaf
Saudi Oil Minister's
press conference
Decrease of U.S.
crude oil inventory
Resumption
of Iraq oil
export
Return to
normal level
of Iraq oil
export
Longer halt
of Mexican
Gulf oil
production
Concerns
for Nigerian
Rebels
Decrease of
U.S. crude
oil
Terrorist
attack at
al-Khobar
Expansion
of Iraq
struggle
Sadr
agreed to
withdrow
its forces
from Najaf
Expansion
of Iraq
struggle
(Sadr)
Labor Risk
– The workers go on strike
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Ten Questions to Ask before Investing
1. What does the company do? 2. Where are the company’s assets based? 3. What type of petroleum does the company specialise in? Oil, gas? 4. Management and Board
– What is the record of management? – Do they have any “skin” in the game? – Are they sharing risk with their remuneration package? – Does the board have technical knowledge?
5. Balance sheet – Debt (high debt is a problem for exploration companies) – Cash (enough for 18 months activities) – debt facilities available? – Is there a history of raising capital and diluting current shareholders?
6. Are there large investors in the company? Who is the largest shareholder and is he an impediment?
7. How much is their share price in relation to their reserves/resources (EV/EBITDAX)? 8. What are their plans? Do they have enough cash to fulfil the plans/ 9. Does the company inform the public of activities regularly on their web page? 10. Is there regular analyst coverage?
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Can we hope for this result?
35
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