Introducing Our New Toy

As I mentioned recently, I am undertaking a project to categorize and compare all U.S. oil and gas companies based on certain metrics. Along with one of our computer programmers, I have developed an Excel spreadsheet that retrieves and analyzes real-time financial market data from the Bloomberg Professional service. The data that is retrieved are 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 first version of this spreadsheet is complete, and I am testing it. My goal is to be able to analyze comparable companies based on the value of their reserves, indebtedness, enterprise value (EV), etc. I have also expanded the spreadsheet beyond the exploration and production (E&P) companies and pulled in every stock — all 361 of them — categorized by the NASDAQ as an energy company trading on a U.S. exchange.

I then sorted those stocks into the various subsectors. There are the E&P companies, the integrated oil companies, the contract drillers, the equipment service providers, refiners and marketers, and the storage and transportation companies and partnerships. Sorting these allows me to tailor the financial metrics I’m comparing to the specific niche within the energy industry.

For instance, consider the standardized measure (SM), which we have discussed here previously. The Securities and Exchange Commission (SEC) requires oil and gas companies 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.

This spreadsheet pulls in the year-end 2014 SM for every company that has oil and gas reserves and trades on a U.S. exchange. I also extract the 2013 SM to determine which companies are increasing their estimated future cash flows, and which are not. However, the SM is only relevant for the E&P companies and partnerships, and the integrated oil companies. A refiner will not report a SM, so we will use different metrics to compare refiners.

Note that the purpose of this spreadsheet is to permit faster comparisons between similar companies. I am trying to remove some of the subjectivity and emotion from the process. But there is still a lot of art to picking stocks, 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 before they result in misleading conclusions.

I frequently hear questions like “Why do you recommend Company A and not the nearly identical Company B?” This spreadsheet is designed to compare the relative financial strength of Company A through Company ZZZ based on the measures I think are important. Therefore, I can more comprehensively and objectively answer that question in one of several ways: 1). “I like Company A more because…” 2). “You bring up a good point. Company B does look attractive relative to Company A.” 3). “I looked at Company A and Company B, and I noticed that Company C is of a similar size, has less debt, and is relatively cheaper.” or, 4). “I took another look at Company A and Company B, and I see weakness developing in their financials. I am going to recommend that we sell Company A.”

In upcoming issues, I intend to use this tool to take very deep dives into various energy sub-sectors. We will look at companies you probably have never heard of. We will uncover some hidden gems, and perhaps make some decisions to sell based on the findings.

Comparing the Integrated Oil and Gas Companies

Today I want to look at two categories of company: The integrated oil and gas giants, and then companies with similar characteristics to one that is a current acquisition target.

First, let’s look at the integrateds. The screen pulled in 19 companies classified as Integrated Oil & Gas and trading on a U.S. exchange. There was either no SM listed or there were otherwise nonsensical values listed for several companies (e.g., InterOil Corporation), so I removed those. Shell (NYSE: RDS-A) is also missing from the list. There was a problem trying to pull Shell into the spreadsheet that we are working on fixing. Petrobras (NYSE: PBR) was on the list, but I removed it as there were clear errors, presumably because they have been late filing their financials.

After culling the list, I ended up with 11 companies classified as integrated oil companies (meaning they have substantial activities beyond oil and gas production). This is a small sampling of the financial metrics extracted, but these are some of the most important ones for oil producers. Note that the SM calculation places no value on any businesses other than oil and gas extraction. Thus, a company with substantial midstream and downstream resources would be expected to trade at a higher EV/SM.

All dollar measures are in billions unless otherwise noted:

• EV = Enterprise Value as of May 12

• 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

• FCF = Free Cash Flow in 2014

• Res = Proved reserves in billion barrels of oil equivalents (BOE) at year-end 2014

• Yield = Annualized dividend yield based on the most recent quarterly dividend

• CR = Current Ratio, current assets divided by current liabilities for the previous quarter

• % Gas = Percentage of the proved reserves that are natural gas

The table is sorted by descending EV, but I can sort by other metrics to determine, for instance, which companies are cheap relative to their reserves:

Companies with an SM of 1.0 are only valued at the present value of their 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 are higher than the current spot prices). Petrobras Argentina, BP, and Cenovus all look cheap according to that metric, while Occidental and Total are valued at twice their future cash flows:


The free cash flow (FCF) tells us whether money flowed into or out of the company in the previous year. A company may have negative FCF if it is investing heavily, but consistently negative FCF is a sign of potential trouble.

The Current Ratio (CR) is a measure of the company’s ability to pay its short-term obligations. A CR of 1.0 means a company’s assets are equal to its liabilities, while a CR of greater than 1.0 indicates better financial health (more assets than liabilities). It is perhaps surprising to see ExxonMobil (NYSE: XOM) with a CR of less than 1, but this is primarily a result of the ill-timed and very large acquisition of XTO in 2010. In any case, that history and financial burden may inform ExxonMobil’s willingness to make another very large acquisition in the near future.

The gas percentage is included because it is an indication of whether a company is primarily an oil or natural gas producer. In recent years, companies that produced more liquids than natural gas have been more profitable.

Matchmaking with BP

By most measures, BP (NYSE: BP) appears to be the best value (by far) among all the companies listed. It had strong free cash flow last year, but is very cheap relative to its SM and reserves. Of course there is a reason for this, which ought to give pause to the many investors who might otherwise snap up shares of BP in a heartbeat. BP will have the specter of unsettled litigation over the Gulf of Mexico oil spill looming over it for years to come.

The cheap reserves and otherwise strong financial measures could make BP attractive to potential acquirers like ExxonMobil. BP’s reserves could be obtained at a fraction of the cost ($8.20/BOE) of the reserves currently on ExxonMobil’s books ($15.40/BOE). But Exxon is still trying to digest the XTO acquisition, so a merger between BP and Chevron (NYSE: CVX) may be a better possibility. It would still be a huge deal, but Chevron could pick up reserves at less than half the cost of the ones it’s booked ($19.80/BOE). Such a merger would create a company roughly the size of ExxonMobil, so it’s not unthinkable.

This is how this screening tool provides value. There has been much talk about the possibility of ExxonMobil acquiring BP, but a close look at the financials of the companies suggests Chevron might be a better fit. It also indicates just how appealing BP may appear to Chevron. But it also highlights the fact that there is a very small pool of publicly traded, integrated companies with the capacity to buy out BP.

Finding the Next Acquisition Target

I can also use the screening tool to look at companies that are being acquired in order to gauge those that could also fill the bill. For example, the past week Noble Energy (NYSE: NBL) said it would acquire Rosetta Resources (NASDAQ: ROSE) at a ~30% premium to last month’s price. So which other companies look like Rosetta?

It just so happens that I ran this screening tool last week prior to the announcement and subsequent rise in Rosetta’s price. On May 7, four days prior to the announcement, Rosetta was an oil and gas exploration company with an EV of $3.1 billion. So let’s use the screening tool to look at all publicly traded E&P companies worth $2 billion to $4 billion to see which ones look like Rosetta. (Of course we could just as easily ignore EV and instead focus on a different valuation metric.)

The screen initially identified 19 companies in this range, but Vanguard Natural Resources (NASDAQ: VNR), Memorial Production Partners (NASDAQ: MEMP) and Atlas Resource Partners (NYSE: ARP) are partnerships, and this results in some distorted financial metrics relative to the corporations on the list. Therefore, I removed those from the comparison. Cobalt International Energy (NYSE: CIE) also appeared on the screen, but it is much more in the “E” phase of the E&P, and therefore some of its metrics were vastly different from those of the other companies in the screen. I therefore removed it as well to give a final list of 15 companies:

Since few of these companies pay dividends, I replaced “Yield” in this screen with “Profit Margin.” And there you have the publicly traded E&P companies that are similar in size to Rosetta. If we look at Rosetta’s financial metrics, we can see why it proved an attractive target for Noble Energy. Rosetta traded at very low EV/EBITDA, EV/SM, and EV/Reserves multiples, yet its profit margin was higher than the group average, it doesn’t have a lot of short-term liabilities, and is primarily an oil producer. Rosetta’s EV/Reserves ratio of $11/BOE looks like a bargain for Noble, whose own ratio (not shown here) is $16.80/BOE.

Of course Noble also had strategic reasons for acquiring Rosetta — namely that Rosetta’s reserves are in the oil-rich zones of the Eagle Ford and Permian Basin. So while the screen above helps narrow down the list of companies that have similar characteristics to Noble, it is important to drill down another level to understand the quality of those reserves. For example, Enerplus has similar financial metrics to Rosetta, but it is a Canadian company with most of its reserves outside of the prolific shale plays.

Laredo Petroleum (NYSE: LPI), on the other hand, has similar financials to Rosetta and prime acreage in the Permian Basin. However, Laredo is more leveraged than Rosetta, and it has a short interest of 19% versus Rosetta’s 12% prior to the acquisition (not shown in the table, but one of the metrics the spreadsheet extracts) — an indicator that more investors are betting that Laredo’s price will fall. Other companies on this screen with multiple attractive takeover attributes are Sanchez Energy (NYSE: SN), Carrizo Oil and Gas (NASDAQ: CRZO), and Midstates Petroleum (NYSE: MPO) — which it should be noted is a penny stock. Kosmos Energy (NYSE: KOS) has an attractive EV/EBITDA, but its reserves are scattered around the world.

Conclusions

Today’s article was an introduction to the new screening tool we have developed that uses the most recent and reliable source of energy company information. This tool greatly expands our ability to cover the entire energy space. After all, it would take a major effort to do detailed analysis on all 361 companies in the energy sector, but this new tool allows more automation of that process. That way, we can spend more time digging deeper into the narratives behind the most promising companies. I am unaware of any other stock screener that takes such a detailed and specialized view of energy companies, and I believe as I screen the various subsectors that subscribers will agree.

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