More numbers!We have been talking about the buyer’s and LNV valuation over the last couple of weeks as a result of the buyout offer for Longview, thus I believe it is pertinent to review the current valuations for the whole sector. For this I will use CIBC Oil & Gas weekly valuation tables (dated Feb. 17
th 2014), I will also take this opportunity to compare each key metric against Longview in an effort understand why LNV trades at a such low valuation.
CIBC dividend paying E&P coverage universe includes the following names:
ARC
Argent
Baytex
Crescent Point
Eagle
Freehold
Lightstream
Long Run
Pengrowth
Peen West
Peyto
Spyglass
Surge
TORC
Trilogy
Twin Bute
Whitecap
EV/DACF for the above sector for 2014 stands at 7.3; Longview current EV/DACF currently stand at 4.4, or 41% lower than the average for the sector.
The per flowing trading multiple for the sector is $91.3K; Longview current per flowing multiple is $58.5K, or 36% lower than the average for the sector.
The average value for each 2P barrel for the sector is $20.89; Longview’s current 2P trading multiple is $9.25, or 55.8% lower than the sector.
The above begs the question, why LNV is trading at such a low valuation?. To answer this question, I am going to look into a number of metrics such as debt, reserve life, payout ratio, netbacks .. etc to understand what is driving this low multiple?
2014 Payout ratio:
Sector: 120%
LNV: 102%
Based on this metric, LNV payout ratio is superior to the sector, even if we were to question LNV’s ability to deliver on its 102% target ratio, it is unlikely that LNV would miss by as much as 20% and overshoot the sector. Thus the answer for the undervaluation can’t be the payout ratio.
2014 Debt D/CF
Sector: 2
LNV: 1.7
Again, LNV debt multiple is superior to the sector and not just in 2014, but the trailing D/CF is also superior at LNV 2 vs. 2.2 for the sector in 2013. It seems debt is not the source of the undervaluation.
P+P Reserve Life
Sector: 14 years
LNV: 16 years
P1 Reserve life:
Sector: 9
LNV: 9.6
Yet again, LNV reserves are superior for both P1 and P2, thus this cannot be the source of the undervaluation.
Oil-NG Split (2014):
Sector: 36% NG , 64% Oil/Liquids
LNV: 18% NG, 82% Oil/Liquids
Considering the higher profitability for oil, again LNV seem to have a better production mix, and thus its discount does not seem to be driven by it is production mix. It is also LNV reserves also reflect this higher oil weighting, even though they trade at 55.8% discount to the sector reserves.
2014 Netbacks
Sector: $36.57
LNV: $38.2
LNV higher oil mix seems to be driving its higher netback estimate than the sector; however the slight increase in netback does not seem to reflect the extent of the higher oil weighting. Perhaps LNV operating costs are higher than they should, but could this justify the company severe undervaluation on EV/DACF, Per flowing and per barrel in reserves?. After all LNV netbacks are still higher than the sector, thus operating costs alone can’t justify the extent of the undervaluation.
2014 Gross production growth:
Sector: 10%
LNV: 5.8%
2014 Per share production growth:
Sector: 3%
LNV: 5.8%
While the sector is showing larger gross growth than LNV, LNV per share production growth is actually better, and since the per share growth metric is what matters, in theory LNV should be valued higher based on this metric. However LNV management has often failed in delivering on its production growth projections, thus the market probably has more faith in the sector estimate, nonetheless even if management delivered half of its growth estimates, we would still match the sector growth. Thus at the worst, this should be a neutral factor.
2014 Per share cash flow growth:
Sector: 8%
LNV: 20.3%
On this metric, LNV looks vastly superior this is largely due to the change in production mix as a result of the increase in oil production (12% increase) and the decline in NG production (9% decline). Again, if LNV management was to significantly miss on its target, the growth should still come ahead of the sector. Thus this cannot be a discount factor for LNV.
Dividend yield
Sector: 6.8%
LNV: 9.6%
LNV yield is 44% higher than the average for the sector; and this is after the recent cut. Of course the cut itself could have shacked investor confidence, but the cut has also improved growth and sustainability.
By looking at a large number of key metrics such as debt levels, production growth, cash flow growth, netbacks, reserve life and the payout ratio we certainly can’t find a clear justification for LNV severe undervaluation in comparison to its peers a discount ranging from 36% to 55.8% discount on a number of key measures.
Since the answer can’t be provided by looking at the tables. There could be issues related to the abandonment liability or possibly there are questions about the viability of some of the company potential acreage. However LNV is trading at such a large discount to its NAV (67% discount) that such liability or potential acreage productivity issues must be more than captured in this discount. In my analysis of LNV’s NAV reserve engineer NAV of $11.4, I applied a 15% discount to the PUDs and 50% discount to the probable reserves (instead of the usual 10% applied by the reserves engineer) and still achieved a NAV of $7.31:
| Discount | 10% | 15% | 50% |
| PDP | $294.50 | | |
| PUD | | $45.50 | |
| Probable (50%) | | | $124.33 |
| | | | |
| Total: | $464.33 | | |
| Debt + WD | $120.80 | | |
| | | | |
| NAV - (debt/WD)* ** | $343.53 | | |
| Per share | $7.31 | | |
Historically some of that discount could have been explained by the Advantage overhang, thus going forward this shouldn’t be a factor. Management execution over the years has been sub-par, this certainly could explain some of the discount, however it is hard to pin point the extent of management/board discount. If LNV valuation doesn’t improve, it might be wise for shareholders to demand a change of management and a change in the board composition in order to improve execution and enhance the board accountability.
In conclusion, there is no real tangible factor that can justify LNV trading at its current $4.95 valuation beyond the market lack of confidence in management/board. LNV should be trading on its own at a price between $6 and $7 today.
In light of the above, I am still in favour of a share deal with another entity that can instantly take us to the $6 to $7 range. As I have shown, a company like TORC can acquire the float for $6.47 and still offer its shareholders a 31% increase in the dividend, meaning if TORC would eventually regain its pre-acquisition yield and trading metrics, the newly issued TORC shares to LNV shareholders (at $6.47) could re-value by another 30% within a couple of quarters, thus offering a shareholder in LNV the possibility to achieve a value of $8.5 by year end, something LNV is not likely able to achieve for a number of years based on the management track record and the capital constrained nature of LNV balance sheet.
Regards,
Nawar