Analysts typically value E&P companies by the "flowing barrel" -- that is, a company's Enterprise Value divided by its daily production in Barrels of Oil Equivalent (BOEPD). This measure has limited value, because it includes natural gas production at a 6:1 ratio to oil. Because natural gas is actually priced at a 35:1 ratio, natural gas-weighted companies look much cheaper than they actually are. The other problem is that not all oil production is alike. Heavy oil produced far from market centers isn't worth that much, whereas light oil near major markets is.
To compensate for the limitations of the flowing BOE metric, we divide it by the "netback" -- the sales price of a BOE less operating cost, royalties, and G&A. This gives us a single metric that addresses both the volume and the profitability of each company's production. The lower the EV/BOEPD/netback number is, the cheaper the company is.
Obviously, we need to consider many other factors when we value an E&P company, most notably its land package, reserves, and management quality. But the EV/BOEPD/netback measure is a great starting point. It's much more informative than the simple flowing barrel measure.
Here are the EV/BOEPD/netback numbers for a range of companies:
|Strategic Oil & Gas||(SOGFF.PK)||87%||$43,583||$44||991|
|Canadian Oil Sands||(COSWF.PK)||100.0%||$108,849||$40||2,725|
A few things immediately jump out at you from this table. Obviously, some gas-weighted companies, like Enerplus (ERF) look super cheap on a flowing barrel basis, but really aren't that cheap. There are also some oil-weighted companies like Pengrowth (PGH), that look good on a flowing barrel basis, but really aren't because they don't make much on each barrel. Let's look at some of the other outliers in a little more detail.
Petrominerales looks like the super bargain in this table. It achieves very high netbacks because it operates in Colombia, where oil typically sells at premium even to Brent prices. But think twice before you buy. Petrominerales has now reported several poor quarters and has drilled a few worthless wells.
Strategic Oil and Gas
Strategic's cheap valuation is probably because of its small size and limited trading liquidity. The company focuses on light oil production in the Steen river, Maxhamish and Duvernay shale. Strategic has grown its production spectacularly, with a 100% compounded annual growth rate since 2010 and 139% just in the last two quarters.
The company has no debt and sports a substantial net cash balance. Last month Strategic felt that its stock was severely undervalued, and announced a Normal Course Issue Bid (NCIB) to repurchase up to nine million shares. We think that Strategic is set to take off as the market comes to recognize its record for explosive production growth.
Pinecrest focuses on light oil in the Red Earth-Slave Point area. Pinecrest's management team includes former Crescent Point executives, who are renowned for their oilfield acumen and operational efficiency. These guys also have a lot of "skin in the game," with a 24.9% (fully diluted) stake in the company.
Pinecrest is able to consistently achieve the highest netbacks in the Canadian oil patch, which accounts for its high standing on our valuation table. Like Strategic, Pinecrest a fast grower, with production expected to explode from 2951 BOPD last quarter to 5000 BOPD at year end.
Why does Talisman appear cheap despite its gas weighting? Most of Talisman's gas production is overseas, where it can charge prices that are three to four times what U.S. natural gas sells for. Talisman also enjoys decent netbacks on its oil production, because much of it is in Europe or the Far East, where it garners prices $30 higher than Canadian production. Talisman has been plagued by mediocre management and blunders on its North Sea platform. The recent departure of its CEO has raised the possibility that it might be acquired. With a $14 billion market cap, it's a big gulp, but it's a hell of a value.
According to our valuation, Crescent Point and Baytex are off-the-charts expensive. There are a few factors at work here. Most importantly, these two companies have the most respected management teams in the Canadian oil patch and excellent, consistent track records. They're simply the most efficient and capable operators around. Investors place high value on that. Secondly, both have relatively high profiles among non-Canadian investors, trading pretty heavily on the U.S. and other exchanges.
The Bottom Values -- It's All About Yield
Yield is the salient characteristic shared by 12 of the bottom 13 companies in this list. This is reflective of the overall markets lately -- investors are reaching for yield and will forego value just to get a dividend.
What I'm Buying
Using this valuation method has called a couple of great values to my attention. At this point, I find Strategic, Pinecrest, and Pacific Rubiales particularly attractive. The top values with good yields are Twin Butte and Eagle.
Additional disclosure: I am not an investment adviser. Nothing in this article should be construed as advice to buy or sell any security.