Screening for Value Upstream
I am currently developing an investment tool that retrieves and analyzes real-time financial market data from the Bloomberg Professional service. The data retrieved is far more comprehensive than you will find at Yahoo Finance, Google Finance, or for that matter any other site I have seen that provides free financial information. The data is also tailored to financial metrics important to the oil and gas industry.
My goal is to be able to analyze comparable companies based on the value of their reserves, indebtedness, enterprise value (EV), etc. The EV is a measure of a company’s total value, which is calculated as the market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents. The EV/EBITDA ratio is analogous to the price/ratio (P/E), but unlike the P/E it factors debt into the equation.
The tool also extracts the standardized measure (SM) for year-end 2013 and 2014. The SM is important for valuing oil and gas producers, sometimes referred to as the “upstream” sector. The Securities and Exchange Commission (SEC) requires oil and gas companies and partnerships to estimate the year-end value of their proved reserves in the annual report (10-K filing). This value is the SM, which is defined as the present value of the future cash flows from proved oil, natural gas liquids (NGLs), and natural gas reserves, minus development costs, income taxes and existing exploration costs, discounted at 10% annually. The SM must be calculated according to specific guidelines set by the SEC.
Note that the purpose of this tool is to permit faster comparisons between similar companies. I am trying to remove some of the subjectivity and emotion from the investment process. But there is still a lot of art involved, as one company may have a much better outlook than other despite having similar metrics. Thus, the data must be interpreted. The industry outlook will also always be important. What is the forecast for oil and gas prices, for instance? Finally, there are often mistakes in financial data, even though Bloomberg is generally regarded as reliable. Mistakes will still creep in, and have to be recognized as such lest they result in misleading conclusions.
Comparing the Upstream MLPsToday I want to look at those MLPs classified as “upstream” and which had oil and gas reserves that were reported to the SEC. (Some “upstream” partnerships, like sand producers or royalty collectors, will not report oil and gas reserves and are thus not represented here.) Here are the upstream MLPs with reported year-end standardized measures, sorted in order of ascending EV/EBITDA:
All dollar measures are in billions unless otherwise noted.
EV = Enterprise Value as of May 15, 2015
EBITDA = 2014 earnings before interest, tax, depreciation and amortization
SM = Standardized Measure, the present value of the future cash flows from proved reserves as of year-end 2014
EV/Reserves = Dollars per barrel of oil equivalent (BOE) of proved reserves
% Gas = Percentage of proved reserves from natural gas
The implication of the SM is that an EV/SM ratio of 1.0 would only value an MLP at the present value of its projected future cash flows from proved reserves as of year-end 2014 (with the very important caveat that the commodity prices used in these calculations — the averages for 2014 — are higher than the current spot prices). The EV/Reserves number is a measure of how much an investor is paying for the proved oil and gas reserves in dollars per barrel of oil equivalent (BOE). Oil reserves are usually more highly valued than gas reserves; “% Gas” shows whether the MLP is predominantly an oil producer or a gas producer.
In the above screen, Sanchez Production Partners (NYSE: SPP) is the cheapest partnership on the list based on both the EV/EBITDA and the EV/Reserves measures. This is partly due to the fact that it is the purest natural gas producer on the list, however other predominantly natural gas producers like Vanguard Natural Resources (NASDAQ: VNR), EV Energy Partners (NASDAQ: EVEP) and Atlas Resource Partners (NYSE: ARP) trade at substantially higher ratios.
Sanchez is also trading at a lower value than its year-end standardized measure, as are Eagle Rock Energy Partners (NASDAQ: EROC) and Mid-Con Energy Partners (NASDAQ: MCEP). The implication of that is that you can buy into those companies at less than the future value of their reserves, again with caveats that there are also other important factors to consider.
At the upper end of the scale, EVEP is the most richly valued upstream MLP according to EV/EBITDA and EV/SM. Investors will pay the most for Mid-Con’s reserves at $16.81/BOE, but it is also the purest oil producer on the list.
Of course these metrics are merely guideposts that highlight potential opportunities. There are others to consider, and there are business factors beyond the metrics. The data and the overall business conditions must be interpreted and evaluated. Debt levels, the quality of the assets and management effectiveness are all important.
The key and most unique metric for the oil and gas producers is the standardized measure, which has no context when considering midstream, downstream, or unconventional MLPs. In future issues we will look at different metrics when screening some of these other sectors.