Valuation of Oil and Gas Exploration companies – SELAN
Someone asked me yesterday about Selan exploration. I have not been a fan of oil industry and consequently could not convince myself to apply mind in it, due to its commodity nature, lack of pricing power for end product, too many variables outside its control.
However, I am open to learning and getting educated. As obvious, one cannot value downstream companies based on conventional metrics such as P/E, Revenue Growth, Debt/Equity, Sales/EV etc just as for mining company I wrote earlier about here.
Oil companies are valued on Proved Developed, Proved Developed Non Producing or Proved Undeveloped (PU). One can introduce a googly of Proved Probable (PP) too.
Please go through this five page valuation article before investing any money on oil exploration companies.
Following is the extract from Annual Report of Selan available at next link.
Oil sector is a high risk and high return sector. Data acquired for seismic evaluation of oilfields & reservoir modeling involves interpretation by advanced software technology and equipment which
is capital intensive in nature and therefore prone to obsolescence coupled with uncertainty in results.
However, the inherent risks of dealing with nature cannot be completely mitigated and that is why drilling activity poses a great challenge and risk. The fluctuation in international oil prices as well as in the dollar
value of the rupee is another factor which adds to the uncertainty of profits in the oil industry.
The private market for buying out of whole companies does not get as out of whack as stock market. Private buyers of businesses act more rationally than investors at large exhibiting their emotional index on tickers.
A couple of recent deals that are done by intelligent buyers should be taken into account before putting a price tag on the company in sight.
Dana Sells itself
If you do want to value the company, you have to anticipate a few extraneous factors.
- Can the oil prices stay high
- What are the reserves of company and what would be cost of extraction of those reserves
- If the reserves will be extracted in possibly next 35 years, then value 200 Crores of Oil extracted in 2045 needs to be discounted adequately to todays price
- You have to ask company for reserves report and trust in the independent valuer that estimated value of reserves
- Stick to Proved Undeveloped resources otherwise you will go down the slipperly slope of EBIDTA rather than PAT
There can be severe shocks on downside and likewise probability of upside. There may be 60% undervaluation on DCF or EV/PU model of Selan but I’d prefer buying companies growing at a consistent and healthy rate. I personally have faith in much stronger secular stories in Indian market. You can call me one trick pony. That said, I will not shell out 40 PE for a 20% grower be it Nestle India Ltd (continues to be my mental block).
Again it can become a doubler, tripler like OMDC but I am happy to give it a pass. If all people were like me Soap/ Shampoo companies would stop advertising as they would see no impact of their Ad budgets, Sugar and Steel stocks would stop being so volatile as I would smoothen them out for next 20 years of cycles. Given that people act irrationally and stocks play out in emotional cycles, I would buy a luxury watch maker when rich people are cutting on expenses, a cruise ship company when people are not splurging on holidays, oil companies when something negative happens for oil industry. Those who do not have the problem of super abundant capital can avoid playing cyclicals unless ofcourse you know what you are doing. Question to ask is, will you buy more of Selan at 150 Rs or book loss at 20% drop ?