The Art of Valuing a Company
Next month, Saudi Aramco, the Saudi Arabian national oil company, plans to offer shares of the company on the Riyadh stock exchange. There is a lot of interest in this initial public offering (IPO), considering that Aramco is the world’s most profitable company.
Aramco’s $111 billion in net income in 2018 was well ahead of No. 2 Apple (NSDQ: AAPL) with $59.5 billion. It is widely expected that after the IPO, Aramco will be the world’s most valuable publicly traded company.
The IPO has been pending for several years, but many questions still abound.
What’s it Worth?
One of the most important is “What is Aramco actually worth?”
It’s a difficult question, because it really depends on how you measure it. There are many ways of putting a value on a company, which typically involve looking at the company’s earnings, cash flow, debt, etc. It’s important to compare the company to peer companies. There are many reasons a company in one sector might trade at different multiples than those of another.
Aramco is the king of all oil companies. Last year it produced about 13% of the world’s oil. It is by far the world’s most dominant oil producer. Its production was about four times that of Western supermajor ExxonMobil (NYSE: XOM).
Aramco’s valuation among 16 banks that offered a valuation ranged from $1.1 trillion up to $2.5 trillion. That’s a huge spread, and it shows how difficult it can be to pin a valuation on a company.
The Dividend Approach
One measure I like to consider in a case like this is the dividend. This is just one consideration, but it does implicitly cover several other measures. To pay an ongoing dividend, the company has to generate enough cash flow. Thus, Aramco must produce enough oil to generate that cash flow. There is a measure of fiscal accountability tied up in paying that dividend over the long term.
Aramco has committed to a $75 billion annual dividend through 2024. At a valuation of $2 trillion, which is the value that has been suggested by Saudi Crown Prince Mohammed bin Salman, the dividend yield would be 3.75%. At a valuation of $1.5 trillion it would be 5.0%, and at $1 trillion it would be 7.5%.
Which number makes the most sense?
This is why the valuation is tricky. Should Aramco’s dividend be considered as safe as that of ExxonMobil, which currently yields 4.8%? How about Chevron’s (NYSE: CVX) at 3.9%, Shell’s (NYSE: RDS.B) at 6.2%, or BP’s (NYSE: BP) at 6.3%?
From a purely business perspective, Aramco’s cash flow is probably safer than that of all the above companies. But the Saudi government will be the majority shareholder of the company, and that’s where the Western oil companies are in a better position.
Aramco shareholders won’t have any recourse if the government suddenly decides to cut or even end the dividend. That could happen if oil prices collapsed for an extended period. Certainly this would pressure Western companies as well, but they might instead make deep cuts to capital spending.
Consider a situation that happened with Petrobras (NYSE: PBR), which is primarily owned by the government of Brazil. A few years ago when oil prices spiked, the Brazilian government forced Petrobras to subsidize the cost of fuel for Brazilians, which directly cost Petrobras shareholders (of which I was one at that time). The lesson is that sometimes the interests of the government will conflict with those of shareholders, and shareholders will lose.
Further, there is more geopolitical risk with Aramco, as evidenced by the September terrorist attacks that knocked five million barrels of oil production temporarily offline.
An investor interested in Aramco’s dividend will have to factor in not only the yield, but the confidence they have that the yield will be stable. The good news is that Aramco does have a long track record of delivering on its commitments. If it says the dividend will be $75 billion through 2024, you can have a high degree of confidence in that number, as long as the geopolitical issues are contained and oil prices don’t collapse.
Given all the factors, I would personally want a yield of at least 5% before I would be enticed by the dividend. A 7.5% yield would be extremely attractive, but probably not sustainable in a world in which the 10-year Treasury yield is under 2.0%. In other words, there would be a lot of money chasing that yield, which would push the valuation higher (and the yield back down).
Looking at it from the dividend perspective, a value of around $1.5 trillion for Aramco seems to be in the right ballpark when compared to Western oil companies. At that valuation, Aramco would indeed be the most valuable publicly traded company in the world, well ahead of Apple’s $1.16 trillion market capitalization.
Editor’s Note: As you’ve just learned, Robert Rapier is an expert at the fine art of valuing a company. Our entire team puts these time-proven financial tools to good use.
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