There are too many articles on Seeking Alpha concerning the top oil companies. These companies have a very similar story to tell. However, the important question is which one is the best bargain among the oil stocks? There is limited analysis comparing the oil majors on similar metrics, even though many analysts are making separate arguments built along the same lines.
Recently, we compared Exxon Mobil Corp. (XOM) to its industry competitors, Chevron (CVX) and Conoco Philipps (COP), and tracked the latest investment status of each. Then, we expertized BP (BP) with its direct competitor -- Royal Dutch Shell (RDS.A). Today, we are going to compare Apache Corporation (APA), Anadarko Petroleum (APC), Conoco Philipps, Marathon Oil Corporation (MRO) and Occidental Petroleum (OXY).
If you are planning to invest in an energy company, then which company do you think has the right energy stock for you? This article will show you their differences with regards to financial status and the ability to continue business operations in the long run. Not only this, but it will also show you their stock status and whether they are undervalued, overvalued or fairly valued. This article will also show you how much margin of safety you would need in buying a particular stock. Will you have relative security in buying the stock? This is one of the strategies of Benjamin Graham and has been adopted by Warren Buffett.
Deep Finance Expertise
The investment valuation for Apache Corporation, Anadarko Petroleum, Conoco Philipps, Marathon Oil Corporation and Occidental Petroleum will be based on the Pricing Model, which is prepared in a very simple and easy way to appraise a company for business valuation purposes. This valuation also adopts the investment style of Benjamin Graham, the father of value investing.
The essence of Graham's Value Investing is that any investment should be worth substantially more than an investor has to pay for it. He believed in thorough analysis, which we call fundamental analysis. He looks for companies with strong balance sheets or those with little debt, above average profit margins and ample cash flow. His valuation seeks out undervalued companies whose stock prices are temporarily down, but whose fundamentals are sound in the long run. His Philosophy was to buy wisely when prices fall and to sell wisely when the prices rise substantially.
My basis of valuation is the company's last five years of financial records - the balance sheet, income statement and cash flow statement. In my valuation, first I will calculate the discounted cash flow, enterprise value and the margin of safety. The relative method was considered as well. Now, let us walk step by step.
1. The Enterprise Value Approach
The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value (EV) is the present value of the entire company. EV takes into account the balance sheet, a much more accurate measure of a company's true market value than market capitalization. It measures the value of the productive assets that produced its product or services, both equity capital (market capitalization) and debt capital. Market capitalization is the total value of the company's equity shares.
The formula for Enterprise Value:
Enterprise Value = Market Capitalization + Total Debt - (Cash and Cash Equivalent + Short Term Investment)
Note: Market Capitalization = Market Price x Number of shares outstanding
Total Debt = Market value of Short Term Debt + Market value of Long Term Debt
Going forward, let us walk through the table below for the calculation of the enterprise values:
The market capitalization of APA, APC, COP and MRO has increased in general from 2008, while OXY is somewhat erratic in movement. OXY has the highest market price while MRO has the lowest market price. The total debts of the five energy companies were greater than their cash and cash equivalents.
The takeover prices of each entire business of APA, APC, COP, MRO and OXY to date, May 9, 2013, are $42.7, $54.8, $94.6, $30.8 and $77.9 billion at a per share price of $77.76, $87.67, $62.59, $34.72 and $89.28, respectively. the equation shows that buying these companies entails 82, 77, 78, 75 and 96% equity plus 18, 23, 22, 25 and 4% debt - for APA, APC, COP, MRO and OXY, respectively.
On the other hand, the market prices to date were $77.76, $87.67, $62.59, 34.72 and $89.28 per share for APA, APC, COP, MRO and OXY, respectively.
2. The Net Current Asset Value (NCAV) Approach
Graham developed and tested the net current asset value (NCAV) approach between 1930 and 1932. Graham reported that the average return, over a 30-year period, on diversified portfolios of net current asset stocks was about 20%. An outside study showed that from 1970 to 1983, an investor could have earned an average return of 29.4% by purchasing stocks that fulfilled Graham's requirement and holding them for one year.
The essence of this method is to identify stocks trading at a discount to the company's NCAV per share, specifically one third below the net asset value or two thirds of the NCAV. Graham's rationale was that this was the minimum value a company would be able to garner if its assets were sold off. This method is one of the oldest documented stock selection methodologies and dates back to the 1930s.
As shown in the table, the market price was much greater than the 66% of the net current asset value per share ratio. This indicates that the stocks were trading above the liquidity value of the companies and therefore the stock prices were overvalued for APA, APC, COP, MRO and OXY, respectively.
3. Benjamin Graham's Margin of Safety
The basic meaning of "Margin of Safety" is that investors should only purchase a security when it is available at a discount to its underlying intrinsic value - what the business would be worth if it were sold today.
The key point for investors to remember is that they should only invest in a company when its stock is trading below what the firm would sell for in the open market. Those investors who ignore valuation concerns and overpay for their investments are operating with a zero margin of safety. Even if their underlying companies do well, these investors can still get burned, according to many passionate followers of Graham.
Before considering buying any stock, I advise you to dig a little deeper and study the results of these calculations. I will guide you step by step. The table will show us the results of the calculations. (click to enlarge)
It shows that COP, MRO and OXY have sufficient margins of safety. Graham considers buying when the market price is considerably lower, a minimum of 40 percent, than the real value of the stock, which Graham called the intrinsic value. I will share with you the formula for the margin of safety and the intrinsic value:
Margin of Safety = Enterprise Value - Intrinsic Value
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
Expected Annual Growth Rate = Long Term Growth Rate or G
The Intrinsic Value factors the current earnings and the growth of the company. The formula is used to identify the difference between the company's value and its price. APA and APC don't have sufficient margins of safety, and therefore their stocks are not good candidates to Buy.
4. Test of Solvency and Liquidity
Solvency Ratios are a tool with which an investor can measure a company's ability to meet its long term obligations. On the other hand, the liquidity ratio is used to measure the company's ability to meet short term debts.
As shown in the table above, OXY had a very impressive solvency ratio of 173%, while APC had the lowest ratio. The general rule of thumb is that a company with a solvency ratio of 20% or above is considered financially healthy. This indicates that the five energy companies will not default on their long term obligations plus the interest on debt. Moreover, it also indicates that APA, APC, COP, MRO and OXY have the likelihood of remaining in business for the long run.
However, a company also needs liquidity in order to survive. Let us see the results of the liquidity ratio for each company. The result shows that MRO will have a hard time meeting short term obligations when due dates arrive, possibly needing its cash, receivables and inventories to meet these obligations. This shows that MRO is not in good financial health, but it does not necessarily mean that it will go bankrupt. APA, APC, COP and OXY each need a little push on their abilities to turn its products into cash. Another way is by being more efficient in collecting their receivables.
Furthermore, the quick ratio indicates that only APC has the ability to meet its short term financial obligations. The four remaining companies may default on short term obligations and will need to use their quick assets. In addition, they need to develop a strategy for increasing their cash.
On the other hand, the Total Debt/Total Asset ratio indicates that 18, 26, 17, 18 and 9% of their total assets were financed by debt for APA, APC, COP, MRO and OXY, respectively.
5. Relative Valuation Method
The Relative Valuation Method for valuing a stock is to compare market values of the stock to the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.
The Price to Earnings/Earnings Per Share (P/E*EPS) will determine whether the stock is undervalued or overvalued by multiplying the P/E ratio by the company's relative EPS and then comparing it to the enterprise value per share.
The table above shows that the stock prices of APA, APC, COP and OXY are overvalued because the market price was higher than the P/E*EPS ratio. MRO has an undervalued stock price because the market price is lesser than the P/E*EPS ratio.
Conversely, the EBITDA/EV indicates that the cash generated income of APA, APC, COP, MRO and OXY was 22, 14, 25, 37 and 16% against enterprise value, respectively. Moreover, the EV/EBITDA tells us that it will take 5, 12, 5, 3 and 7 times the cash earnings of APA, APC, COP, MRO and OXY, respectively, to recover the costs of buying each of these entire businesses.
Make or Break for Investors
The stock prices of APA and APC were overvalued, while COP and OXY had fair valued stock prices. In addition, MRO's stock price was undervalued. Moreover, the solvency ratio indicates that the five energy companies were financially healthy. However, the liquidity ratio indicates that MRO may default on its short term obligations. OXY had a very impressive solvency ratio. However, the acid test ratio indicates that OXY will be having a hard time paying its short-term obligations and that is not a good sign. Furthermore, APC passed the acid test, meaning it will not default on its short term obligations, and its solvency ratio indicates that the company is financially healthy. However, its margin of safety was not sufficient.
I recommend a Hold on the stock of APA, COP and MRO and a Buy on the stock of APC and OXY.
I believe that the best bet in the selection (APA, APC, COP, MRO, OXY) is Anadarko Petroleum.