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Introduction

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.

To define the juicy oil bargains, we recently compared the stocks of the leading oil/gas companies in the following selections:

Selection 1: Exxon Mobil (XOM) - Chevron (CVX) - Conoco Philips (COP)

Selection 2: BP (BP) - Royal Dutch Shell-Class A (RDS.A)

Selection 3: Apache Corporation (APA) - Anadarko Petroleum (APC) - Conoco Philips - Marathon Oil Corporation (MRO) - Occidental Petroleum(OXY)

Selection 4: TOTAL (TOT) - Exxon Mobil - Petrobras (PBR)

Today, our final selection of juicy oil stocks (for finding out the best bargain among the bests) include BP, Chevron, Shell (Class A), Total and Exxon Mobil. We will use deep finance expertise of these stocks to define the right winner without fear or favor.

Concerning the investment valuation on these companies, the margin of safety was more than 50%, which is above the requirement of Benjamin Graham of at least 40-50% below the true value of the stock. Royal Dutch Shell operates as an independent oil and gas company worldwide. The company explores for and extracts crude oil, natural gas and natural gas liquids. Furthermore, the news states that Shell has announced a final investment decision in the Stones ultra-deep-water project, a Gulf of Mexico oil and gas development expected to host the deepest production facility in the world. Would this make Shell the best bet for now?

Deep Finance Expertise

The investment valuation on BP, Chevron, Shell, Total and Exxon Mobil will be based on the Pricing Model, which is prepared in a very simple and easy way to value a company for business valuation purposes. This valuation 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. The enterprise value is the present value of the entire company. It measures the value of the productive assets that produced its product or services, and both the equity capital (market capitalization) and debt capital. Market capitalization is the total value of the company's equity shares. In essence, it is a company's theoretical takeover price because the buyer would have to buy all of the stock and pay off the existing debt, pocketing any remaining cash. This gives the buyer solid ground for making an offer.

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:
(click to enlarge)

In my spreadsheet, the market capitalization of XOM has moved erratically, while the market capitalization has decreased by 5% and 8% from 2008 for BP and TOT, respectively. In addition, the market capitalization of RDS.A and CVX increased by 36 and 6%, respectively. CVX has the highest market share price followed by XOM.

The takeover price for each business to date, May 13, 2013, was $166.8, $233.9, $239.6, $130 and $408 billion at $52.13, $120.51, $76.23, $57.33 and $89.26 per share for BP, CVX, RDS.A, TOT and XOM, respectively. The market price to date was $43.18, $123.23, $69.06, $50.37 and $90.14 per share for BP, CVX, RDS.A, TOT and XOM, respectively.

BP, RDS.A and TOT have more debt than cash and cash equivalents, and therefore their enterprise values were higher than their market capitalizations. In addition, CVX has less debt than cash, while XOM has the same percentage of debt and cash.

2. The Net Current Asset Value 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.

Now, let us see the results of this approach for these five companies.
(click to enlarge)

The table shows that the stock prices of the five oil and gas companies are overvalued, because they were trading above the liquidation value of the company. XOM has the lowest liquidation value, while BP, CVX and have a liquidation value of $16.5 and $16 billion, respectively. Furthermore, the 66% of NCAVPS represents only 7, 6, 4, 9 and 0% of the market share prices. Therefore, the stocks were overvalued. It indicates that the stocks of the five oil companies have not passed the stock test of Benjamin Graham.

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.

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.

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)

As shown above, each of the five oil and gas companies has a sufficient margin of safety - above the requirement of Benjamin Graham of 40-50% below the intrinsic value. The intrinsic value of the five oil and gas companies is $330, $ 703, $381, $272 and $615 per share for BP, CVX, RDS.A, TOT and XOM, respectively. These are the true values of the stocks. Therefore, it indicates that the five oil companies are good candidates for a buy.

Moving forward, in line with the calculation of the margin of safety is the growth of the companies. The margin of safety factors the intrinsic value and the intrinsic value factors the earnings per share (EPS), the sustainable growth rate (SGR) plus the annual growth rate. The sustainable growth rate factors the return on equity (ROE) and the payout ratio. Thus, the computation for the margin of safety goes a very long way.

The table below will show us the results of the calculations for growth. Let us walk through the table.
(click to enlarge)

XOM has the highest SGR and ROE, while BP, CVX and TOT have had almost the same level of growth - from 21% to 25%. In addition, TOT has the highest payout ratio at a 46% average followed by RDS.A at 43%. Overall, XOM has the highest growth followed by CVX and then TOT.

The sustainable growth rate (SGR) shows how fast a company can grow using internally generated assets without issuing additional debt or equity, while the return on equity shows how many dollars of earnings result from each dollar of equity.

4. Cash Conversion Cycle

The Cash Conversion Cycle is the time it takes a company to convert its resource inputs into cash. It measures how effectively a company is managing its working capital.

The results shows that it will take 17, -6, 13 37 and 14 days for BP, CVX, RDS.A TOT and XOM, respectively, to convert their resources into cash. As you may have noticed, CVX shows negative results, which is not a good sign. On the other hand, TOT and XOM showed an erratic movement, which indicate a decreasing of value. Moreover, BP has shown an improvement year after year because of the decreasing number of days from the period 2008 into the trailing twelve months. RDS.A in general showed a decrease of 47% from 2008. Furthermore, it indicates that the management is performing well operationally.

5. Relative Valuation Methods

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.
(click to enlarge)

It tells us that the stock prices of BP, RDS.A and TOT were overvalued because the market prices were greater than the P/E*EPS ratio. The stock price of CVX was undervalued because the market price was lesser than the P/E*PS ratio. Furthermore, the stock price of XOM was fairly valued because the market price and the P/E*EPS ratio are the same.

Additionally, the EBITDA/EV was 21, 27, 24, 22 and 21% for BP, CVX, RDS.A, TOT and XOM, respectively. The EV/EBITDA tells us that it will take 7, 4, 4, 5, and 5 times the cash earnings of the BP, CVX, RDS.A, TOT and XOM, respectively, to recover the cost of purchasing the entire business of each. In other words, it will take 7, 4, 4, 5 and 5 years to recover the costs of buying the entire business of each.

Final Verdict

Overall, the stock prices of BP, RDS.A and TOT were overvalued, while the stock price of CVX was undervalued and XOM has a fair valued stock price. In addition, the margin of safety was sufficient for all five oil and gas companies. Moreover, the cash conversion cycle indicates a good sign for BP and RDS.A. Therefore, I recommend a Hold for the stock of CVX, TOT and XOM and a Buy for the stock of BP and RDS.A.

Bottom Line

I believe the best bet in this selection (BP, CVX, RDS.A, TOT, XOM) is Royal Dutch Shell - Class A.

Source: Juicy Oil Bargains - Part 3: Which Is Best Among The Best?