There are two ways to evaluate oil and gas companies. The first is looking at various multiples relevant for the industry and comparing them to other companies trading on the market. The second is the NAV model at the asset level and DCF model at the corporate level. Lets see what kind of valuation we can get using all three methods for Enerplus.
1. Oil And Gas Companies Multiples
Here are some key multiples.
Market cap = $4.53 billion
EV = $4.9 billion
EV/EBIDTAX = 5 (industry average 4.6)
EV/Book value = 1.04 (inudstry average 1.1)
EV/Proved resources = $3.19 (valuation on the lower end)
EV/Daily production = $62,000 (below average of $111,821)
P+P reserve life index = 10.7 years (Dec31 2010) lower than average
The above multiples suggest that at the current price of $24 dollars Enerplus stock is fairly valued or slightly overvalued.
2. NAV Model
The net Asset Value of Enerplus P+P reserves (future prices discounted at 10%) is $4.8 billion, which is slightly above the market cap and slightly below enterprise value. The NAV model also points out to more or less fair valuation.
Analysts covering the stock have a consensus of $30 target price. One of 11 analysts have a hold rating on the stock; five have a buy rating. The $30 target price seems to be based more on historical share price. The stock traded in this range for the most part of 2010 and first quarter of 2011. Assuming that it will come back to this range when oil prices rebound seems logical but it may or may not happen.
Historically, the company has been paying out more than it was making, resulting in deficit accumulation of $2.3 billion which was "reclassified" against share capital on Jan. 1, 2011, during the conversion of the fund to a corporation. This made the accumulated deficit disappear from the balance sheet. During 2006-2010, if we subtract total cash from investing activities, from cash from operating activities, we get $1.583 million. Total dividends paid out during 2006-2010 stand at $2.564 million. The difference is $981 million. During same years the company raised $831 million by issuing stock and $726 million by issuing debt. It is obvious that paying such dividend doesn't make a lot of sense from financial perspective. However, as we know, stocks with good yield are priced higher by the market.
What is interesting in the case of Enerplus is that in spite of a seemingly obvious increasing debt trend, debt to equity remains pretty stable at 7.6%. Moreover, equity per share has been always increasing, rising from $20.47 per share in 2007 to $22.20 per share in 2010. That is assuming that the assets are reported in fair value by the company.
So far, the company has been successful in replacing depleting reserves by adding new P+P reserves by completing extensive drilling programs. Added reserves compensated funds borrowed to pay a seemingly unsustainable dividend. The question remains if the company will be able to continue doing it in the future.
To support these plans in the near future the company sold over $1 billion of non-core assets in 2010, including the majority of oil sands interests, and redeployed those proceeds into the purchase of approximately $900 million of new growth assets. Through this activity, Enerplus has acquired more than 500,000 net acres of prospective land in three of the premier plays in North America — the Bakken light oil play, the Marcellus shale gas play and in the Deep Basin region of western Canada.
Production guidance for the rest of 2011 has been slightly reduced to 76,000-78,000 BOE/day. The company doesn't offer any guidance on 2012 production at this point.
Enerplus in its financials is using a term "funds flow." They explain that funds flow is calculated based on cash flow from operating activities before changes in non-cash operating working capital and decommissioning liabilities settled.
Here is what the management says in the second-quarter report:
We expect to finance our negative working capital with our funds flow and bank indebtedness. We have continued to maintain a conservative balance sheet as demonstrated below:
|Financial Leverage And Coverage||June 30, 2011||Dec 31, 2010|
|Long-term debt to funds flow (12 month trailing)||0.7x||1.0x|
|Funds flow to interest expense (12 month traling)||13.7x||17.4x|
|Long term debt to long term debt plus equity||11%||18%|
At June 30, 2011, we were in compliance with our debt covenants. We expect to have adequate liquidity from funds flow and our bank credit facility to fund capital spending and working capital requirements for2011. We expect our capital spending and dividends to exceed our funds flow in 2011 and 2012, and that our debt-to-funds flow ratio will
increase during this time as we continue to invest in earlier stage growth assets where there is a longer lead time to production and funds flow. We anticipate our debt-to-funds flow levels will decrease after 2012 as production and funds flow from our growth plays are realized .Our payout ratio, which is calculated as dividends divided by funds flow, was 73% for the second quarter of 2011 compared to 55% for the second quarter of 2010. Our adjusted payout ratio, which is calculated as dividends plus capital spending and office capital divided by funds flow, was 185% for the second quarter of 2011, compared to 106% for the same period in 2010. Our adjusted payout ratio increased during2011 due to higher capital spending levels, which are not generating immediate production or funds flow, as well as lower funds flow due to lower production and cash taxes in the U.S. resulting from our Marcellus disposition.
Oil price fundamentals remain strong, with worldwide demand for oil at 89 million barrels per day and supply of 59 million barrels per day. In a long-term perspective, the prices for oil should aise again. Maybe the prices will start rising again to the point that they will start hurting economy and drop again when speculators moving trillions of dollars will decide to exit. Most probably oil prices will be volatile in the coming years, but my belief is that fundamental trends will continue to create upward pressure. In the 2010 report the management promised 10-15% growth in production; however, in the second-quarter report, the management is cautious stating that they will be able to provide better guidance in the fourth quarter 2011.
According to the management we will see improved financial performance in 2013. Senior notes of the company mature in 2014 and 2015, which will have an impact on financial results during these years.
My conclusion is that the dividend is sustainable for the company till 2013-2014. I'm not going to predict the target price, but I think it should be around the current price, which is more or less fair.