Views on Life & on Equity Investing

Wonder, Wealth & Abundance

Valuation of Oil and Gas Exploration companies – SELAN

with 10 comments

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.

VALUATION

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.
http://www.slideshare.net/hfbe/oil-and-gas-company-valuations-business-valuation-review

RISKS

Following is the extract from Annual Report of Selan available at next link.

http://www.selanoil.com/annualreport.html


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.

DEALS

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 Buys

http://www.dana-petroleum.com/Press/pr_140610.htm

Dana Sells itself

http://www.bbc.co.uk/news/10486598

CAVEAT

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 

FINAL THOUGHTS
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 ?

Written by amitdipsite

December 18, 2010 at 11:05 pm

Posted in Uncategorized

10 Responses

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  1. He must know what he is doing. We as investors shouldn't let anyone pull rug from our feet. One ought to know either the promoter or valuer of oil. Then too, there are extraction risks which are capex intensive.

    Multibagger

    December 19, 2010 at 6:29 am

  2. Hi Amit,

    I do agree the risks involved in a commodity based company.
    But i think the story here is little different….here is a case of a company which is just utilizing 5% its potential and look the returns this stock as given.
    With 3D sesmic activity going on the other fields to be completed soon…u might just see the sales going up drastically.With excellent promotor at the helms and very low debt on it balance sheet and with Oil prices heading higher….this stock will be a huge wealth creater in coming days.Goldman Sachs and JP Morgan has come out with reports on oil heading higher to $120.Even if the oil stays at $60 per barrel….this stock should atleast quote a mkt cap of atleast 2000 cr.
    Historically the company as always rewarded it shareholders handsomely.I think some exposure to this stock will be gainful in coming days

    Regards,
    Vikas

    Regards,
    Vikas

    Vikas

    December 19, 2010 at 12:15 pm

  3. Hey Vikas,

    I agree that it is likely to be a value stock but if you have 20-25% certain slow sure grower then why even consider B grade options.

    Learning from Munger is to rule out 99% of ideas by comparing them to top 10 ideas.

    5% of PP (Proved Probable, ooh shady) 71 million barrels. Its really dangerous to convert this into $ figure because you will get 40,000 Crores or something like this but drilling it will take 70 years.

    If we trust that this is the amount of reserves they have (I have no idea hot to trust this number), even if they have these many million barrels, then they have 50% market cap value of global deals that have been done this year. i.e potential to double once but then vagaries of Oil will kick in. Yes it can triple or quadruple too but with uncertainities of oil price.

    Its a bet on Oil so its better to just play Oil futures and put stop losses.

    Oil well drilling companies across the world have returned 50 baggers in last 15 years across the board.

    Regards

    Multibagger

    December 19, 2010 at 9:11 pm

  4. Hi Amit,

    Whats your take on hardcastle.. If time permits take a look at it..

    kittu

    December 22, 2010 at 4:50 pm

  5. Hi,

    Strong group but management does not seem to be interested in share price growth. They are making more than enough money through private ventures.

    Multibagger

    December 23, 2010 at 6:44 am

  6. Thanks amit for your feedback..

    I have hawkins & zydus.. I am more convinced on indian middleclass growth than anything.. This two forms 60% of my investment.. If i were you, would be sell both and buy cravatex or simran or venkys or any small cap for that matter??.. Would welcome your comments.. The idea here is that hawkins specially would be giving lower eps for this yr and hence would like to switch to somethin which is more fancier.. At later point would like to switch back to hawkins..

    kittu

    December 23, 2010 at 4:50 pm

  7. You are on to right type of stocks, I am sure you would find your way around.

    I'd buy whatever is growing faster and can pay upto 35PE for high quality. If Hawkins starts growing topline at 40% and priced at 2000 Rs (EPS 60 Rs * 35) I'd buy it.

    Cravatex and Photoquip seem cheapest of the lot, I'll wait for December buy 10% of my portfolio if sales are up by more than 40%, wait for March 2011, if sales are again up more than 40 -50 % buy another 10% of my portfolio. For Cravatex, with low equity base EPS can shoot to 150 Rs in 1-2 year and on bad quarters can go down, so there will be higher volatility.

    Venky's will be re rated too in coming years.

    Multibagger

    December 23, 2010 at 6:33 pm

  8. Amit,

    I bumped into your blog through fourstocks.com. Excellent posts – I really liked the ones on Bufet and Munger.

    If time permits, can you please let me know your views on Ganesh Polytex? It is a micro cap company into the business of manufacturing Recycled Polyester Staple Fiber (RPSF) from PET waste. They are the biggest listed player in India in this business and currently are carrying out expansions and forward integration. Their NPM (though still low) is steadily increasing. Would appreciate your views.

    Regards,
    Rajesh

    Rajesh Bhat

    December 25, 2010 at 8:01 pm

  9. Hi Rajesh,

    Potential is present without a doubt. There are two negatives,

    a) Company cannot grow without signifact capex at every stage

    b) Entry of new players is un restricted

    Its still worth a small bet and needs to be actively monitored for debt going out of hand or net profit margins suffering.

    Regards

    Amit

    Multibagger

    December 26, 2010 at 12:21 am

  10. Dear Amit,

    You rightly mentioned 2 points, I am also watching Ganesh Poly since a long and had position until few days back (until I find this blog/Amit :-))..
    Another point is: they are doing Equity Delusion for Capex..

    Rahul Kumar Paliwal

    December 26, 2010 at 6:38 pm


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