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Oil and Gas Equipment & Services

Oil and Gas Equipment & Services. Module 5: Valuation using Forecasts of Cash Flows. Jeff Ritter. Agenda. Review Module 4 Forecasting Overview Assumptions Module 5 Valuation Using Forecasts of Cash Flow. World’s Largest Oil F ield C ompany. Forecasting Performance.

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Oil and Gas Equipment & Services

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  1. Oil and Gas Equipment & Services Module 5: Valuation using Forecasts of Cash Flows Jeff Ritter

  2. Agenda • Review Module 4 • Forecasting Overview • Assumptions • Module 5 Valuation Using Forecasts of Cash Flow

  3. World’s Largest Oil Field Company

  4. Forecasting Performance (Valuable opportunities may be lost) Multiple Method Theoretically based models for valuation • Integral to business decisions • Investing • Value a firm’s common stock before purchasing shares • Managing a firm effectively • Value different strategic investment decisions • Creditworthiness • Forecast the same information but choose to focus on the borrower’s cash flows. • Make best possible forecast NOT just conservatism

  5. Goal of Forecasting Right Answer Enter into debate about assumptions Demonstrate the process by which forecasting toward valuation can be done and the decisions involved Assumptions are relied on

  6. Forecasting Process DO NOT forecast the firm’s non-operating, financing, activities Because we are valuing the enterprise and then adjusting for the current value of NFL to determine the value of equity Forecast revenue via forecasts of sales growth rates. Forecast EPAT via forecasts of EPM and components of EPM Forecast NEA via forecasts of EATO and components of EATO

  7. Module 11 Module 4 Parsimonious forecasting Full informational forecasting Difference Level of detail used to form assumptions

  8. Forecasting • Measured: • enterprise level • segment, division or product line. Sales growth forecasting • Assumptions: • revenue growth • expense change in relation to revenue. • EPM components EPAT forecasting • Assumptions: • Relation between B/S accounts and revenue • Components of EATO Balance sheet forecasting

  9. Forecasting Sales Revenue • Most crucial and difficult estimate • All other enterprise income statement and B/S accounts derive directly or indirectly • Both EPAT and NEA change with with revenue • Revenue growth impact: • Lead: Inventory • Grow concurrently: Income statement , A/R • Lag: plant assets (only when growth is sustainable)

  10. Factors considered in Sales Growth Estimate • Historical sales growth • Halliburton • Comparables • Analyst Expectations • High, Low, and consensus estimates: 2013, 2014, 2015 • Oil Rig Counts • Oil Prices and Demand • Earnings Call • “Mid to high single digit sales growth”

  11. Volatile Historical Sales Growth

  12. Analyst Expectations for Halliburton

  13. Rig and Well Counts

  14. Sales Growth Assumption Historical growth for Halliburton and the Industry Rig and Well Count Ex: New construction Oil and Natural Gas Price & Supply/Demand Factors Historical growth has been inconsistent, but growth seems to relate closely to rig and well count. Oil prices and demand are expected to increase, but energy efficiency has slowed the consumption growth in countries such as China. Total rig count is on the decline dropping 10% in the US. 7.2% Includes GDP Growth 3% and inflation considerations 1.5%.

  15. Enterprise Profit Margin EPAT Sales Preferable Measures how much operating profit the firm earns from each sales dollar.

  16. Level of gross profit the firm earns of products (sales revenue-COGS) What impacts EPM? • Level of competition • Product pricing • Level of enterprise expenses the firm requires to support services • Overhead costs: wages, marketing, R&D Firm’s willingness and ability to control costs

  17. Potential Issue* Observation • Consider looking at “EPM from Sales” excludes the following: • Impairment charge • Discontinued operations • F/S translation • Gains/losses on cash flow hedges Growth, then decline in most recent year *We don’t want to focus on events with zero expected value

  18. EPAT Sales Refining the EPM Analysis with EPAT from sales, does not result in a significant difference • We expect EPM will remain at approximately 9.4% • Competition entry by small companies will prevent an increase in this area

  19. The stability of the enterprise operations’ profitability related to sales of Halliburton does not experience much change when considering EPAT from sales. • The EPM is still relatively stable

  20. Enterprise Asset Turnover Preferable How to increase? Sales Avg(NEA) Increase sales for a given level of Investment in EA and/or reduce the amount of EA necessary to generate sales We want The amount of sales the firm realizes from each dollar invested in enterprise assets. Measures the productivity of the firm’s enterprise assets.

  21. How to increase EATO? Operating WC • Easier than reducing long term net enterprise assets. • How? • Firms can collect their A/R faster, reduce inventories, delay payments to suppliers. Long term EA Difficult to reduce. The level of property plant and equipment required by the the firm is determined by the nature of the firm’s products or services than by management action. Reduce operating working capital (Current enterprise assets-current enterprise liabilities)

  22. Sales Avg(NEA) Observation Growth then decline • We expect EATO forecast of 1.56 • Extracting is becoming more complex and we • expect additional NEA to generate less sales dollars

  23. EPM and EATO Do not blindly compare the performance of firms across different industries Higher EPM in one industry vs. another does not indicate superior management. Utilizing pure play comparables is ideal EPM and EATO are the weighted average in the various industries the company operates Typical ratios may depend on capital intensity of the industry

  24. Assumptions Sales Growth 7.2% EPM 9.4% EATO 1.56 *Calculating to the nth decimal place looks more professional but does not make the results more accurate.

  25. Issues with Forecast • We are external users: We only have access to general purpose financial statements that are given. • None of the companies are a “pure play” • May need to add additional comparables. • Look at additional information because sales growth is consistent in the industry, but the pattern needs further analysis. • Technip metrics are not consistent with the other firms (Eliminate)

  26. Valuation Forecasts DCF

  27. DCF Issues Confidence LOW • Why? • Sales growth rate not based on full information • Continuous growth rate • WACC (Is it correct?) Increase in sales growth decreases enterprise value Determine growth rate for continuous value using additional data Determine if the Bloomberg WACC needs to be modified

  28. Any Questions?

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