In the previous parts I have gone through all the important parts in valuing an oil company (Part 1, Part 2, Part 3, Part 4), so now it is time to put the theory into practice and I just happened to have found an undervalued stock to use in the example.
This is a stock that I came across on another blog which interested me a lot and was part of the reason I started the ‘How to value an oil company’ series. Novus Energy is a small oil producer in Dodsland Viking in Saskatchewan (Canada). Novus has an emerging Viking resource play in Provost as well as some Cardium and Dunvegan lands in Wapiti.
The reason I picked this stock is that it is simple. It is only a small junior player and new wells are coming on line quickly. That means very fast growth in its overall flow rate BUT remember the charts in part 3, flow rates for new wells will fall by around 50% a year. So growth can’t be extrapolated and will in fact reverse in the future. It has been drilling between 13 and 24 wells every quarter for the last 5 quarters. Who knows how long this will last for and what the flow rate will go to before finally declining.
For this reason I don’t think too much weight should be placed on the EV / production rate
EV / Reserves
Instead let’s move straight to EV/proven reserves. We can use the latest annual filing to find these. Novus’ enterprise value is $222.75m and it has gross proven reserves of 14,853 boe so the ratio is $15.00 per boe.
Next lets look at EV/Proven + probable reserves, or EV/2P as it is known as. That’s $222,750 / 22,716 boe = $9.81 per boe.
Now remember these aren’t old reserves, so they are still at the cheapest stage of the production process. That means the reserves will command at least the average selling price of similar wells in the region, we don’t need to fear Novus wells being somehow cheaper for a reason.
In its latest press statement Novus states that “finding, development and acquisition costs, excluding future development capital (“FDC”), were $9.41/boe for proved plus probable reserves and $12.25/boe for proved reserves.”
So it is costing companies $12.25/boe in total to get proved reserves discovered and flowing and Novus is selling for $15/boe. I for one cannot see the logic in that, it appears undervalued on this metric.
EV / Cash flow
The trailing 12 months cash flow was about $48m (I’m not including any capital expenses – which is being spent on new wells). Due to high growth $15m of that is in the last quarter alone, so it is a conservative number to use.
EV / cash-flow is therefore 4.6, which is an attractive number (but,again, don’t forget cash-flow decreases dramatically over the first few years).
And finally onto the most important measure in my opinion, companies will state this in their annual filings so no calculation necessary. The Net Present Value of future oil revenues from proved reserves after tax was $217.5m at the end of 2012. That is a whisker below the EV of $223m.
The real insight here comes when we compare this with another operator in the same region, Raging River (RRX). It has similar production, reserves and resources so offers a great comparison. It trades for $52.53 per boe (proven) compared to Novus’ $15, and on a EV/cash-flow multiple of more than 10. The real kicker here is it sells for a EV/PV10 ratio almost triple that of Novus.
Novus has a lot of growth potential before the inevitable decline in its cash-flow but it isn’t guaranteed. The market seems to be predicting a big decline for Novus but that seems completely unfounded. Of course the big risk here is the price of oil, but if one where to go short Raging River this could provide an effective hedge against that given it’s loftier valuations.
This is not a comprehensive analysis, Novus has many other risks which need to be considered. Its debt is the worst kind – a bank loan repayable on demand without notice by the bank. Management have stated their intention to keep debt levels below 1.5x annual cash flows however. And there is a strange disclosure at the end of the annual report that certain director payments are capitalised rather than expended. This is ridiculous.
But it isn’t a deal breaker and my further investigations came across no good reason the Novus should trade at such a large discount.
Disclosure: I am long Novus