If all one needs to do to build a winning portfolio is use an EV/EBITDA screen, investment management will be the easiest job on the planet.
In reality, the mass of data produced by any screen still needs to be sorted before investment decisions can be arrived at. Balance sheets need to be scrutinized, accurate forward estimations need to be made, and reconciliations have to be done. Stocks simply shouldn't be purchased in a vacuum.
This is why a peer group comparison is a useful exercise. It is an "apples to apples" evaluation of similar companies in the exact industry, hopefully of similar size and with similar balance sheets. A well structured comparison provides an investor with insight as whether or not valuations are appropriate. If something in the review appears out of order, more in depth research may be required.
In prospectuses, underwriters typically include a peer group analysis. Sometimes the cross section is acceptable, sometimes not. A high quality stock generally stands up well to scrutiny among other high quality stocks.
"Do it yourself investors" should get in the habit of performing the same due diligence with their potential acquisitions. This may be done by performing their own peer group analysis, using the highest quality stocks that they can find.
As an example, let's look at the valuations presently being applied towards Arawak Energy (ABG in Canada and ARWKF in the U.S). ABG shares are presently selling for about $2.85 Canadian ($2.60 U.S). Arawak operates exclusively in the "Former Soviet Union".
A decent peer group review should compare ABG to other producing firms operating exclusively in the FSU. They should be have reasonable production and 2P reserves. They should have similar market caps and similar production metrics. Only then, will one be able to make an informed assessment about the merits of Arawak vs directly comparable companies.
ABG has a present enterprise value of $524.1 million U.S. Arawak presently produces about 7800 bpd in Kazakhstan and Russia. ABG has total 2p reserves of 73.2 million barrels. Arawak's most recent forecast indicates that 2006 production may average about 9000 bpd. In 2007, the forecast rises to 13,000 bpd. One can estimate that 2006 revenues will exceed $140 million U.S. and EBITDA will exceed $78 million. In 2007, an estimate of total revenues in excess of $206 million and EBITDA of $119 million seems sensible.
This prices ABG at 6.7X forecast 2006 EV/EBITDA and 4.4X 2007 forecast EV/EBITDA respectively. Investors are paying about $7.16 per barrel for 2P reserves.
How does this compare to FSU peers?
West Siberian Resources (WSBRF $.94 U.S.) is a rapidly growing firm with a strong balance sheet and significant production, relative to its enterprise value. WSBRF trades on the Swedish Stock exchange and has 1.1 billion shares outstanding. At closing prices of 6.85 SEK (Swedish Krona) the company has a market cap of roughly $1.034 billion U.S. Add in the net debts (total debts - cash and equivalents = $94 million) and the total EV is $1.128 million. In 2006, Repsol YPF purchased 10% of the outstanding fully diluted shares of West Siberian.
West Siberian holds 2P reserves estimated to be in excess of 176.2 million barrels, all in the FSU. In addition, the firm owns a tiny oil refinery which processed 740 bpd in 2005.
Current oil production currently exceeds 19,000 bpd and West Siberian estimates that oil production will average 23,000 bpd in 2006. In 2007, WSBRF forecasts that production will surpass 30,000 bpd by year end. All of the fields owned and operated by West Siberian are newer (not yet in decline) and are ramping up production. WSBRF indicates that production from existing fields may eventually exceed 50,000 bpd.
2006 capital expenditures are forecast to exceed $85 million U.S., and will be funded from existing cash flow. As with all oil companies operating in the Soviet Union, the high levels of production are offset by low pricing received for oil domestic oil sales, and high levels of taxation. I use an $61 U.S. price per barrel for Brent in 2006. At that price, West Siberian will receive net revenues of roughly $32 per barrel. This suggests WSBRF should generate revenues in excess of $269 million U.S. on total production of 8.4 million barrels. EBITDA is forecast to exceed $156 million.
In 2007, assuming that West Siberian meets the production target forecast of 30,000 bpd, revenues may exceed $339 million, and EBITDA would exceed $196 million.
This prices the West Siberian at a forecast 2006 EV/EBITDA of 7.2X, and suggests a forecast 2007 EV/EBITDA of 5.7X. The EV implies that investors are effectively paying about $6.4 U.S. per barrel of 2P reserves.
http://www.westsiberian.com/files/AGM_presentation_May11_2006.pdf
URALS ENERGY ($7.25 UREYF) has 115 million shares outstanding on a fully diluted basis. The firm went public in August 2005 and trades on the London Stock exchange. The firm has 2P reserves in excess of 225 million barrels. With net debts of $120 million, the firm has an EV of $954 million.
Urals is presently producing about 10,000 bpd. It appears that the firm will produce an average of 11,000 bpd in 2006 and an average of 16,000 bpd for 2007. Revenues and EBITDA for 2006 may exceed $148 million and $85 million. In 2007, Urals may generate revenues and EBITDA of $205 million and $120 million respectively. Capex is forecast to exceed $66 million in 2006.
This prices URALS at 11.2X estimated 2006 EV/EBITDA and 7.9X 2007 EV/EBITDA estimates. Investors are paying about $4.24 per barrel of 2P reserves.
http://www.uralsenergy.com/pdfs/investor_presentation_may_2006.pdf
Sibir Energy (SIBYF $9.14 U.S). Sibir has roughly 290 million shares outstanding on a fully diluted basis. The EV is $2.4 billion. SIBYF owns 50% of the new Salym group of fields and are being developed jointly with Shell. Salym are the largest major new fields to be developed in the Soviet Union within the past 36 months and hold proven 2P reserves (net to Sibir) of more than 400 million barrels. Total 2P reserves for Sibir (including other fields) exceed 446 million barrels. Sibir also owns 22.5% of a very modern Moscow oil refinery that produces 200,000 bpd. Sibir is the giant of Russian juniors, and represents the best in class. While most juniors have a number of oil "pools" that add up, Sibir has a truly world class "field" being developed by one of the seven sisters of the oil business.
Currently, Sibir produces in excess of 22,000 bpd and estimates average production of 25,000 bpd for 2006. For 2007, the firm anticipates average production in excess of 38,000 bpd. EBITDA is forecast to exceed $200 million in 2006, and $325 million in 2007. Capex is forecast to exceed $150 million in 2006
By 2009, Sibir anticipates net production from current fields in excess of 70,000 bpd.
http://www.sibirenergy.com/content.asp?c_id=8
At current prices, Sibir sells for 12X forecast 2006 EV/EBITDA and 7.4X forecast 2007 EV/EBITDA. Investors are paying $5.38 per 2P barrel of reserves.
In light of these valuations, how does ABG stack up?
In terms of EBITDA, ABG is certainly cheaper than the peer group. Arawak shares appear underpriced by about 10% on a 2006 EV/EBITDA and about 30% on a 2007 basis when compared to West Siberian. When compared to URALS and Sibir, ABG looks even better.
In terms of 2P reserves, ABG is about 35% more expensive than the peer group. The average price paid per barrel for the 3 FSU stocks in this analysis reserves are $5.28 U.S. per barrel.
In light of this peer comparison, ABG's relative undervaluation on an EV/EBITDA basis appears to be linked to the relatively low level of 2P reserves.
A peer group analysis serves another purpose. Sometimes one or more companies in the cross section will turn out to be the better relative value. Other times, results may imply that an investor would be well served to diversify their original investment, among several of the companies contained within the list.
In the case of this FSU cross section, one could certainly make a case for suggesting Sibir Energy as a pick in a " small to mid cap" portfolio. In terms of long lived reserves, balance sheet and future growth, Sibir seems to look attractive. With an EV of $2.4 billion U.S, it is virtually 5 times the size of ABG and doesn't fit into a "micro cap" account. In fact, given the size of the Sibir, it quickly became apparent that it wasn't right to include the firm in the peer group to begin with. That said, once I started the analysis, the excercise became intriguing and Sibir became a story of its own. The firm recently raised about $400 million U.S. of cash. Sibir has not identified any specific need for this cash.
In terms of a micro/small cap portfolio, one could argue for splitting a proposed investment equally between Arawak, West Siberian and Urals. In this fashion, one blends the smaller reserve base of Arawak into the much larger reserve base of West Siberian. Add to this the very cheap reserves of Urals, and an investor has a pretty interesting stock. The low EV/EBITDA of Urals is offset by the high EV/EBITDA of ABG. By investing equal amounts in all three, the overall effect is to buy one oil stock with the following metrics:
forecast 2006 EV/EBITDA of 6.95X and 2007 forecast EV/EBITDA of 6X and an overall price per barrel of 2P reserves = $5.93
Alternatively, one could choose simply to buy ABG on the basis of its exceedingly low EV/EBITDA relative to the peer group. If nothing else, one does so knowing that the low price of ABG is at least partially due for a low perceived level of reserves.
Those seeking 2P reserves at the lowest possible price may probably opt to own shares of URALS Energy. It's becoming very hard to find 2P reserves anywhere on the planet for less than $4.25 U.S. per barrel and the company demonstrates strong production growth.