Oil & Gas Valuation:
- EV/EBITDA - Referred to as the enterprise multiple or the earnings before interest, taxes, depreciation and amortization (EBITDA) multiple. This takes the enterprise value (market cap + debt – cash) and divides it by EBITDA. One of the main advantages of an (EBITDA) multiple vs. price-to-earnings ratio (P/E) is that it is unaffected by a company's capital structure. The EV/EBITDA ratio compares the oil and gas business, free of debt, to EBITDA. A low ratio indicates that the company might be undervalued, as compared to its peers within the same industry.
- EV/Production – Also referred to as price per flowing barrel, this is a key metric used by many oil and gas analysts. This takes the enterprise value (market cap + debt – cash) and divides it by barrels of oil equivalent per day (BOE/D). A high multiple would indicate that it may trade at a premium to its peers, and if the multiple is low amongst its peers it is trading at a discount. Of note, this ratio does not take into account the potential production from undeveloped fields.
- EV/2P - This method helps analysts understand how well resources will support the company's operations. This multiple can be an important metric to use to evaluate the valuation of acquiring properties when little is known about the cash flow. Reserves can be proven, probable or possible reserves. Proven reserves (or 1P) are typically referred to as P90, or having 90% probability of being produced. Probable reserves are referred to as P50, or having a 50% certainty of being produced. Possible reserves only have a 10% change of being produced. Proven and probable reserves are most commonly used together and is referred to as 2P. If this multiple is high, the company of interest would be trading at a premium for a given amount of oil in the ground.
- P/CF – The price-to-cash flow multiple is used frequently by Oil and gas analysts. In contrast to earnings, book value and the P/E ratio, cash flow is harder to manipulate. Notably, this leverage can be misleading if there is a case of above average or below average financial leverage. To calculate this ratio, take the price per share of the company that is trading and divide it by the cash flow per share (cash flow = operating cash flow – exploration expense / fully diluted shares). This measure adds back in non-cash expenses, depreciation, amortization, deferred taxes and depletion. In times of low commodity prices multiples expand, and during high commodity prices multiples decrease.
- EV/DACF – Many analysts prefer to use EV/DACF vs. P/CF as firms with higher levels of debt, or more leverage, will show a better P/CF ratio. This multiple takes the enterprise value and divides it by the sum of cash flows from operating activities and all financial charges that include interest expense, current income taxes and preferred shares.
- P/E – The price-to-earnings ratio is not often used in valuing E&P companies, but is frequently used to value oilfield services companies. P/E ratio is the company's share price to its per-share earnings and tells us how much investors are willing to pay per dollar of earnings. As the name implies, to calculate the P/E, you simply take the current stock price of a company and divide by its earnings per share (EPS). In calculating earnings, a company’s trailing twelve month earnings or forward 12 month earnings are typically used. Companies that aren't profitable, and consequently have a negative EPS, pose a challenge when it comes to calculating their P/E (note that analysts will typically use a book value calculation instead). If a company has a P/E higher than the market or industry average, this means that the market is expecting big things over the next few months or years. The downside of using P/E is earnings is an accounting figure that includes non-cash items (and can be manipulated). The result is that we often don't know whether we are comparing the same figures, or apples to oranges.