Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Gold/Mining/Energy : Big Dog's Boom Boom Room -- Ignore unavailable to you. Want to Upgrade?

To: Bearcatbob who wrote (112867)	10/31/2008 8:44:16 AM
From: Ed Ajootian	2 Recommendations Read Replies (2) \| Respond to of 206148

BCBob, yes, that's the big question. I found an excellent discussion of valuation in a recent piece by Credit Suisse (thanks again Dennis, see post #112861), an excerpt from which is copied below. Right now the market seems to be thinking about $7 gas and $60-65 oil as being a good guess for the LT price. My gut tells me that each of these figures will turn out to be low once we can get within, say, 6 months of getting to the end of this recession, and I'm now starting to think about buying stocks of companies who are in the middle of long-term projects, and whose stock price is not dependent on what next quarter's cash flow is. The key is finding companies that have the financial wherewithal to see their projects through, whose LT projects would be economic at $60 oil. Anybody got some ideas along these lines? A copy of the CS valuation discussion follows: A Greater Focus on Multiples vs. NAV?: With the broad E&P group 63% off Q208 highs, most E&Ps are now trading below the discounted value of proved reserves (NAV) at a wide range of commodity price scenarios. In fact, on a reserves basis, producers trade at just $2.15 per Mcfe on average, suggesting the group is discounting ~$6.50-7.00 long-term natural gas price and $60-65 longterm oil. With investors worried about the group’s ability to fund both growth budgets and even proved undeveloped reserve (PUD) development, reserve based valuation (NAVs) appear to be losing its previous dominance as a valuation tool. Likewise, the average stock is at a 40% discount to NAV on proved reserves with no obvious reasons for discrepancies amongst the group in many cases (see Exhibit 1). ¦ NAV Can Breakdown As Useful Tool At Times: We are big proponents of NAV based analysis but have witnessed a break-down of NAV as a useful indicator in tough energy markets before (1997-2000 and 2002). We admit that NAV has its faults and that trading multiple analysis can be a helpful add-on in tougher times. Problems with using NAV based valuation in today’s environment include: 1) changes to discount rates greatly impact NAVs (is PV10 the right discount rate in a world with a higher cost of capital?), 2) an inability for M&A to eliminate NAV discounts due to a lack of external funding for most companies, 3) the risk to longtail reserves coming off the books at lower year-end price decks (many companies have booked wells with reserve profiles out 30 to 50 years) and 4) the sensitivity of long-term commodity price assumptions has a magnified impact on NAVs. ¦ Multiples are Helpful Tools, But Have Shortcomings Too: Ultimately, we think the market will return to NAV based valuation (as it has tended to), but this will require a re-opening of the credit markets which would enable M&A to close gaps to NAV. EV/EBITDA multiple comparison can be helpful in stock selection in uncertain times as it measures current year cash flow, rather than a series of less visible cash flows (NAV models tend to go out 15 years or more). Meanwhile, multiples have significant shortcomings in valuation analysis including 1) the lack of consideration for reserve life index (R/P), which greatly affects the financial and operational risk profile of the company (i.e. longer reserve lives are lower risk and should trade richer), 2) inability to capture the percent of reserves that are undeveloped, which gauges future capital needs 3) uneven future cash flow streams (companies may have a stronger/weaker growth profile in future years that is not measured but is accounted for in NAVs) and 4) in-the-money hedges can depress multiples making stocks appear cheaper than they really are. ¦ Multiples Look Inexpensive: Ultimately, we think NAV is a stronger relative valuation tool, but in the near-term multiples analysis should be considered as a helpful add-on after understanding the shortcomings and adjustments that may need to be made. To make multiples comparisons fair, credit can be given to growth profile, reserve life and mark to market hedging gains/losses. In the attached tables (Exhibits 2-7), we have prepared a series of EV/EBITDA multiples scenarios for 2009 at various price cases and looked at multiples on both a hedged and unhedged (our preference) basis. We would say that stocks look inexpensive on all scenarios relative to the long-term average group multiples of 5.5 to 6.0x for the E&Ps. At the CS price case of $75 WTI oil and $8.25 per MMBtu NYMEX natural gas, the group is at 3.8x on a hedged basis and 4.2x on an unhedged basis. At the 2009 calendar futures curve at ~$71 and ~$7.30, the hedged multiple is 4.0x and the unhedged is 4.7x. At a harsher $65 oil and $6.50 gas case, the group is 4.4x hedged and 5.4x unhedged (more in line with historical multiples). Companies which screen well on the harsher price case include Noble Energy (NBL), Apache Corp (APA), Newfield Exploration (NFX), Pioneer Natural Resources (PXD) and Anadarko Petroleum (APC).