Energy/Natural Resources Modelling Test

For your upcoming modeling test with the Energy group, here's what you need to know based on the most helpful WSO content:

1. Focus on Midstream/Downstream Businesses: Since you're coming from a generalist M&A background and were told not to be an expert, it's likely they'll test you on a midstream or downstream business. These are closer to a "normal operating company" compared to upstream businesses, which involve more specialized metrics like reserve booking and exploration costs.

2. Key Valuation Metrics:

   • P/E Ratio: A straightforward metric often used for quick comps.
   • P/FCF (Price to Free Cash Flow): Important for assessing cash flow generation.
   • EV/DACF (Enterprise Value to Debt-Adjusted Cash Flow): A common metric in the energy sector. DACF is calculated as CFO + after-tax financing costs + before-tax exploration expenses +/- working capital adjustments. This metric is used because it adjusts for financing decisions, making it more comparable across firms.
   • Dividend Yield: Often relevant for downstream businesses, as investors may look for high-yield securities.

3. Midstream Specifics:

   • Midstream businesses often involve pipeline transportation, storage, and processing. Historically, many were structured as MLPs (Master Limited Partnerships), but with tax changes, many are transitioning to C-corporations. This makes their financials and valuation more generalizable.
   • Capital structure is crucial, so be prepared to analyze debt levels and financing.

4. Downstream Specifics:

   • These businesses focus on refining crude oil into products like gasoline, kerosene, and other petroleum products. Major players include Marathon, ConocoPhillips, and Valero.
   • Look for asset sales or geographic exposure in the case study, as these can materially impact the business's risk profile.

5. 3-Statement/DCF Modeling:

   • Ensure you're comfortable building a 3-statement model with integrated assumptions for revenue, costs, and capex.
   • For DCF, focus on projecting cash flows and calculating terminal value. Be aware of industry-specific nuances, such as the use of DACF in cash flow projections.

6. Preparation Tips:

   • Brush up on the basics of midstream and downstream operations, as well as the valuation metrics mentioned above.
   • Review recent deals in the energy sector, especially those involving midstream or downstream assets, to understand transaction dynamics.
   • Practice building a simple 3-statement model and DCF for a hypothetical energy company, incorporating metrics like EV/DACF and dividend yield.

By focusing on these areas, you'll be well-prepared for the test. Good luck!

Sources: Oil and Gas Overview, Oil and Gas Overview, Offer Decision Help Needed