Best metric for valuation

[Fraser921]

In my opinion, the best metric for valuation is

FCF/Enterprise value. A multiple on cash flow makes no sense as it ignores capex, interest exp, etc

FCF is free cash flow, all the ins and outs. If a company has a 1 b in operating cash but spends 1 b in cap ex it has 0 ZERO cash flow. It's running in place , not going forward or backwards. They may have running room but what good is running room if you are running in circles generating 0 cash

Enterprise value is the value of the common stock priced in the market + debt

Example a company has 300 m shares outstanding that are trading at 10. The equity piece is 3,000
say debt is 2,500

The enterprise value is 5,5 billion

In this example fcf of 0/5.5 billion investment is a zero ROI. You can put your 5.5b US treasuries and earn 5.5 %

Id like to make a minimum of 10 % return. 10 % of 5.5 b is 550 m. If it cant earn 550 m I'm not interested

Ive heard comments that at say at $ 65 oil companies are making money. Yes they are making money but they aren't making an acceptable return . And at 2.25 NG it's devastating.

[Petroleum economist]

Bill, I notice that you like to post at times opinions which deviate a bit from the mainstream. Nothing wrong with that.

I ran your suggested screening criteria of having at least a 10% ratio between the FCF and the sum of debt + market value through my data base. FCF is oil price dependent. I used WTI=$ 75/bbl.

I must conclude that your investment options are limited. None of the major US oil and gas companies are meeting your criteria.
Your choices are limited to three smaller companies (Riley Exploration, Sandridge, Viper Energy) or to some Canadian companies (Gear Energy, Hemisphere, Ovintiv, Tamarack Valley, Vermillion, Whitecap).

I used long-term debt in above. If I use the sum of long-term plus short-term debt the list becomes even shorter

A couple of trusts (Blackstone, VOC), have no debt and not a lot of capex and could qualify. They however need to spend money on acquisitions to maintain their production levels.

I note that you are not considering the state of the balance sheet or whether the production is growing or shrinking. Maybe you should look at that as well.

Good luck. Lots of wisdom.

[ChuckGeb]

Harry, are you going to post the results of your FCF and yield analysis for all the companies you follow? It would be extremely useful info imho.

[Petroleum economist]

Chuck, the yield for the top 25 companies between 2024-2028 is already included in the additional data in the presentation that I send out weekly.

I am not sure if the FCF stand-alone is a useful number to share. It just is a number. I use the FCF in relation to the balance sheet and the company shareholder pay-back policies to estimate amounts of dividends and share buybacks over time.

[dan_s]

Just remember that any company in any industry can generate free cash flow by liquidating / depleting out its assets.

Upstream oil & gas is a capital intensive business. "Running Room" is worthless unless it is developed.

BTW "Operating Cash Flow" is net of interest expense.

If your goal is building a portfolio that pays dividends then ranking companies by FCF is a good screening method. However, for dividends to be maintained, companies must have capital expenditure programs that build future revenue streams.

All of our Sweet 16 companies are free cash flow positive.

[knusser58]

Hi to all,
just to add some food for thought.
Only using Operating Cashflow (OCF) times a multiple to get to a target price is perfectly fine, very commonly used and gives you a good idea.
However, let's say you have two companies with the same OCF, but one company has a capex 50% higher than the other company and projects the same growth as the other (for example: One company has much less prolific oil and gas reserves, more expensive to develop).
In this case, only using OCF x a multiple gives the same result for both companies, whereas the company with the lower capex should be a lot more valuable.
It is best to ALSO consider some kind of measure of OCF after capex, VOLUMETRIC GROWTH and LEVERAGE in order to arrive at a price target.
Dan most certainly accounts for those three factors and others (reserves and 'running room', etc.) by using/adjusting the multiple he applies for different companies, but this is done in a more combined and all in adjustment.
Dan, in your models the above three metrics (CAPEX (already shown in your models), VOLUMETRIC GROWTH (already shown in your models) and LEVERAGE (not shown in your models, but you have it in your database, see weekly summary)) can easily be incorporated to arrive at quantitative metrics that help any of us determine price targets considering different ratios.

Incorporating metrics specifically in your models like:
FCF: OCF-Capex
Enterprise Value: Market Value + DEBT
EBITDA
FCF/Market Value (yield in %)
FCF/Market Value + Production Growth Rate (yield in %)
EBITDA/Enterprise Value (yield%)
EBITDA/Enterprise Value + Production Growth Rate (yield in %)

This would enrich and add some much more value to your models and would give us more ratios directly to consider in our valuation.
I would also include these metrics in your weekly summary tables. We would clearly have more valuable info and in a comparative way. We could rank the different portfolios using more metrics. This would be very helpful and would save us a lot of time in our valuations.
All of the additional data to accomplish this you already have in your database and once you incorporate it in your models and your weekly summary it will be calculated automatically.
Hope this helps.
Regards,
Klaus

[dan_s]

Thats a lot more work. Remember there is just one of me.

This is why I recommend all of you subscribe to Harry's company ranking system, which all EPG members are getting for free in August. Harry's database of 80 companies has a lot of valuable information. His individual company evaluations are "priceless".

As Klaus points out, I do consider debt and growth potential ("Running Room") in my valuations by adjusting the multiples I use. In my opinion, upstream companies with strong balance sheets, that are funding steady growth with lots of operating cash flow should be trading for AT LEAST 4X operating cash flow. They deserve higher multiples if they are generating enough FCF to pay dividends, which all of the Sweet 16 do except for VTLE.

PS: Harry and I both have over 40 years of oil & gas industry experience. We both worked in business development evaluating companies and asset packages for large publicly traded companies (Shell and Hess). We value companies slightly differently, but we agree on most valuations. We both value the long-term potential a company's asset base.

[ChuckGeb]

All good discussion. i understand Dan's approach which he has consistently used for a long time. I am of the belief that with the dominance of shale properties owned by most of the companies followed, that due to high rate initial production, rapid decline properties yielding 2/3 of their reserves (guestimate) in initial three years +/- using operating cash flow alone as Frazer indicated can be a bit deceptive. I think the shift in the industry from growth as being the primary driver to a balanced approach emphasizing a decent return to shareholders makes FCF a critical metric.

I think the market's discounted valuation of Vital with its emphasis on growth and no current shareholder return is indicative.

The recent Form 8-K (dated 4/18/24) filed by FANG in the Endeavor acquisition has an analysis by Jefferies that used the following methodology:

With respect to Endeavor, Jefferies reviewed publicly available financial and stock market information of the following seven publicly traded natural gas and oil exploration and production companies that Jefferies in its professional judgment considered generally relevant to Endeavor for purposes of its financial analyses, based on size, asset profile and financial characteristics (which are referred to as the “Endeavor Selected Companies”), and compared such information with similar financial data of Endeavor prepared and provided by Diamondback management to Jefferies:
• ConocoPhillips Company
• Coterra Energy, Inc.
• Devon Energy Corporation
• EOG Resources, Inc.
• Ovintiv Inc.
• Occidental Petroleum Corporation
• Permian Resources Corporation

In its analysis, Jefferies derived multiples for the Endeavor Selected Companies from the following metrics:

• the estimated total enterprise value divided by EBITDA for calendar year 2024 (“2024E EBITDA”),
• the estimated levered free cash flow yield (calculated as EBITDA plus realized hedge gains (loss), less interest, cash taxes, and capital
expenditures divided by equity value) for calendar year 2024 (“2024E LFCF yield”), and
• the estimated total enterprise value divided by EBITDA for calendar year 2025 (“2025E EBITDA”), and
• the estimated levered free cash flow yield for calendar year 2024 (“2025E LFCF yield”).

So clearly FCF is important & commonly used metric as well as EBITDA which in most cases should approximate OCFPS which Dan notes in his case is reduced by interest.

The results of their valuation are included in the report.

[Fraser921]

Chuck/all, good comments

[dan_s]

The real value of an EPG membership is that we have hundreds of members with decades of industry experience. Many of them don't post to the Forum, but they send me good suggestions via email.
"Networking" with smart people is the true value of your membership.

[ChuckGeb]

I agree that EPG is a great value and have learned a lot over the years I have been a member. Forum has been the source of many good ideas. Appreciate Dan and all members who post frequently.