I have two questions, which I hope someone can kindly clarify for me.
- I often see developers' relative valuations being expressed on a discount/premium-to-net asset value basis. NAVs are in turn based on independent appraisal of the developer's portfolio value.
Is that valuation metric more relevant for REIT-type businesses (build/buy-and-let), rather than homebuilders (build-and-sell)? or can it be used across the board?
I am hesitant to use P/E (or other measures based on "recognized" figures) for build-and-sell type developers, due to the time lag between when pre-sales are made and when corresponding revenue is recognized (varies from 1-2 yrs). I feel this lag renders accounting figures incomparable between different companies. This is especially relevant for China and certain emerging market countries where developers are highly dependent on pre-sales (I do not know what industry practice is in US/WE).
can anyone enlighten me on what measure is more appropriate, as I can't find a consensus between different research reports I am reading right now.
- Assuming independent appraiser arrives at portfolio value using DCF, to arrive at NAV for the whole firm, I use the following calculation
= estimated portfolio market value minus net debt
That is, in arriving at NAV above, I should NOT subtract from portfolio value the balance of operating liabilities (shown on GAAP/IFRS statements), as they are already reflected in estimated portfolio value and I will be double counting if I do so.
My logic is that DCF valuation of portfolio (essentially an NPV figure before financing) already reflects any operating liabilities associated with projects in portfolio, INCLUDING advance payments from customers, if any.
I really hope this does not sound confusing. As usual, I would be very grateful for any thoughtful input.
Your truly,
Good questions. There's a lot here and it will be difficult to cover, but hopefully I can give you a quick overview.
When you buy a REIT, you are truly buying a portfolio of real estate assets, so understanding the underlying value of that real estate (NAV) is tantamount to understanding the value of the REIT. That's why NAV is such a crucial component of REIT valuation. Yes, there is some platform value to a REIT (perhaps it can operate real estate more efficiently and extract greater revenues through tenant relationships) that warrants a premium (or a discount, in the case of poor management, excess leverage, etc.) to NAV, but NAV is often the basis of your analysis.
Homebuilders are much trickier, and I'll note that I have less experience with them, but I can tell you the business is fundamentally different. When you buy a homebuilder, you are not just buying the property portfolio (which is generally its pipeline of develop-able land and inventory of unsold housing stock), but also the ongoing value of the business on the assumption that it can, over the long run, sell houses at a higher price than it costs to build them, not unlike the concept that McDonald's can sell a Big Mac for greater than the cost to make one. However, a homebuilder is not quite like McDonald's either. There is an active secondary market for houses (fortunately there is no such market for leftover Big Macs), and at times (like the past few years) there is so much secondary inventory of housing that development is unprofitable and makes little sense. As a result, the value of future opportunities is incredibly lumpy. So to some extent, the value of a homebuilder is anchored in the NAV of its current property portfolio, but in a market where development is profitable, you have to ascribe considerable value to future profits outside of the current pipeline.
Your second question is essentially what operating assets and liabilities should be credited or debited against the value of underlying real estate to get to NAV. This gets complicated. In theory, the idea of NAV and its predecessor before deducting net debt, which is Gross Asset Value (GAV), is that it should proxy the value of the real estate if you had to sell it on the private market today. So the question is, based on the method you used to get to the portfolio's underlying value to a private buyer, what operating assets would you likely get to keep and what liabilities would you remain obligated to pay? Generally speaking, there are local customs regarding the pro rationing of a property's operating assets and liabilities in a sale. Typically, but not always, a buyer of the real estate will give the seller a credit for operating assets like security deposits, prepaid expenses, etc., but deduct for operating liabilities. In other words, conventional portfolio valuation methods most likely DO NOT adequately account for operating assets and liabilities, so you should add the value of "Net Tangible Assets" (operating assets minus operating liabilities) to your portfolio value before subtracting net debt to arrive at NAV. Make sense?
This is very different from how you do a comparison between public companies. When you compare public companies, you assume that the firm value incorporates the net value of the operating assets minus operating liabilities because a firm deserves credit for being able to reduce its capital intensity and operate with less net working capital (higher operating liabilities, lower operating assets). This is irrelevant, however, in an NAV calculation, which values the portfolio as if it is being disposed rather than treating it like an ongoing business.
Net Asset Value “NAV” (Part 1) (Originally Posted: 02/18/2012)
Net Asset Value “NAV” – Part 1
Net Asset Value is a key component when trying to value an oil and gas company. It is a value of the company based on the production and sale of all of its producing and future producing assets.
The estimated amount of reserves is taken from an engineering and geological report, generally done by an outside firm. The quality of these reports differs, which is a main problem in the certainty of NAV calculations. It contains a price deck which forecasts the commodity prices, a reserve base which estimates the amount of oil and gas the company owns, and a production estimate which assumes some level of production growth, usually short term and then a decline in reserves for the life of the asset which is anywhere from 5 to 30 years or more.
The calculation is done by multiplying the total yearly production estimates by the annual commodity price estimates to get an annual cash flow. This is also commonly discounted to present value net asset value “PNAV”.
Another step to yield the NAV is to take your price estimate for the commodity and calculate your Netback, or your net realized cost per barrel. This would include subtracting costs such as production, general and admin, royalties, development and abandonment costs and taxes. This will yield your final realizable price and give you your NAV.
The oil and gas reserves are grouped into two main categories; 2P reserves, which are proved and probable, and 3P reserves which are proved, probable and possible. It is important to notice which NAV you are looking at, as 2P reserves offer a better base for valuation and 3P reserves offer a better potential upside target.
The final conclusion taken from NAV is the price to net asset value “P/NAV” ratio. A company trading below 1 is at a discount and a company above 1 is at a premium to its NAV.
What are some companies with interesting P/NAV ratios?
re-ib-ny thank you v. much for your insight! Very informing and to the point.
Real estate analysis can get rather hairy as I begin to discover :)
Wow thanks! I was just trying to value an oil and gas company as part of an interview process, and was wondering about the whole NAV thing so this was really helpful. Can't wait for part 2
How does p/nav differ from p/b?
Interesting to read, thanks.
Also I read that the discount rate is generally assumed to be 10%. Do we simply discount the annual cash flow by 10%? Sorry if this sounds stupid but do you not have to incorporate things like capex and changes in net working capital into the PNAV?
Not stupid at all...valuation in oil and gas isn't fundamentally different from any other industry and clearly the price deck X production is only going to give you your revenue...
Oh dear....I hope part 2 explains all the other cashflows you need to take account of!
For anyone totally green to this and the concept of NAV in general, this is worth a read http://www.investopedia.com/articles/stocks/07/oil-gas.asp#axzz1mlqlGqfZ
Oh dear....I hope part 2 explains all the other cashflows you need to take account of!
For anyone totally green to this and the concept of NAV in general, this is worth a read http://www.investopedia.com/articles/stocks/07/oil-gas.asp#axzz1mlqlGqf…]
Totally agreed London Calling... tough to address type curves and IP rates with b factor declines in an intro overview though...
Awesome, thanks.
How accurate is this?
I cover e&p's. My coverage universe generally oscillates between having 20% upside to NAV at the top of the cycle to as much as 80% upside to NAV at the lows. Right now I'm looking at about 35% upside to NAV, so the stocks aren't offering a heck of a lot of value right now. It is worth noting, however, that if you break the universe into oil names and gas names, an interesting dichotomy emerges; oil names (especially SD and DNR) have lots of upside to nav at current strip pricing while gas names have virtually none (with the exception of companies like DVN and CHK).
The biggest problem with NAV: it assumes that good projects get funded. This is not always the case. Perfect case study: CHK. A huge cash flow hole in '12 and '13 has caused the company to trade at a substantial discount to NAV becuase it is widely believed that CHK will have to sell of some of its portfolio just to keep moving in today's gas price world. Selling high-quality assets means that the NAV you're looking at today won't necessarily be reflective of the company a year from now. They will have to likey sell the Permian and do more VPP's or a Miss Lime JV to not be in a world of hurt as the year goes along. I think that they will be able to do it, though, so that stock is interesting down here...
Yeah they said in a press release that they will likely sell their Permian. Splitting the oil and gas names and finding more upside in oil-weighted names shouldn't be a shock at all. Obviously the main driver of the value of any of these companies is going to be commodity price, and if your companies reserve base and production is weighted towards gas which is trading like shit, then your stock price performance is going to suffer.
Sorry guys, just noticed a paragraph forgot to be included, which is basically costs that must be subtracted from your NAV calculation, it is edited above and I included it below.
Another step to yield the NAV is to take your price estimate for the commodity and calculate your Netback, or your net realized cost per barrel. This would include subtracting costs such as production, general and admin, royalties, development and abandonment costs and taxes. This will yield your final realizable price and give you your NAV.
Bump.
Am looking at some O&G companies on the side (was curious and am looking at it for my own PA) - how do you effectively come up with your 2P and 3P assumptions? The companies I have looked into don't seem to report it and broker reports don't seem to provide much color regarding to numbers they are using. Is it just a pure estimate based on acreage and region?
Also, how do you guys estimate the production curve for your NAV model - does it vary by group or is there a standard way to look at it? The sample I have seen assumes a 5% decrease after Y5 (end of op model projection period) - not sure if there is a science behind choosing this.
Sorry if this is obvious - thanks!
Net Asset Value Part 2 - Are all NAV comparable? (Originally Posted: 02/21/2012)
With most oil companies largely evaluated on their net asset value, and no standard guidelines for NAV reserve value, are they all comparable?
It is important to analyze the capital requirements needed to bring the reserves to production. If they are significant this could lead to trading at a discount to its NAV.
One example of NAV needed to be discounted is Arcan Resources (CVE:ARN), who came out with their newest NAV in November of $7.17; up 67% from their previous estimates. Arcan has been trading around $5 - $6 for the last few months. Why? Because it is an example where their needs to be significant future Capex over the next few years to fully capture their value of their reserves. Without sufficient cash flow from current operations, the company will have to raise capital to bring the newfound reserves online. This will result in a decrease in value to shareholders due to either dilution or raised debt levels.
Comparables are also often used, especially with companies located in the Western Canadian Sedimentary Basin (WCSB). However, it is important to only compare companies with similar asset classes, such as heavy bitumen or natural gas liquids, as the quality or extraction process and location can make significant changes to the value of the reserves.
Most commonly we see NAV discounts needed in junior and mid size oil and gas producers. These values are largely based on the data provided by the geological and engineering firms, which differ in quality and contain a level of personal opinion. Does the industry need to establish standards for the reporting of oil and gas reserves in calculating a NAV?
What are some other companies that should be mentioned?
Nobodoy uses (or shouldn't use) pure resource value to asses value for upstream firms. Geography and geological play (as well as obviously GOR ratios) play a HUGE role on NAV per unit of resource, but can't think of a standard that could be used to generate uniformity across the board, its a highly complex and dynamic issue to be dealt with a standard reporting policy.
The industry has standards for reporting oil and gas reserves. There are requirements for booking 1P, 2P, and 3P reserves based on SEC methodology. Further, petroleum engineering firms who conduct reserve audits have industry standards that they use to risk reserves. If you go through an advisory process, for example, 90% of your time spent in diligence will revolve around auditing engineers arguing over appropriate risking and how you should treat each classification of reserves. Different windows in different plays will have different risking tied to them, but in terms of historically reported numbers, those have a clearly defined classification that is regulated by the SEC. If the question is should there be standards with respect to what operators report in their investor presentations, I think that to a large degree they go based off of their quarterly audited figures, which again are overseen by reserve engineers. In terms of valuation, transactions undertaken in North American shale plays are done almost exclusively on Net Asset Value. Any reputable firm providing strategic advisory to a client will advise on transaction opportunities based upon NAV. If you look at many of the recent marquee deals like KKR / Samson, STO / BEXP, or BHP / HK, the targets are evaluated with NAV being the dominant value driver. Additionally, if you look at historical regression analysis of equity research price targets over the past 3-5 years, you can determine that P / NAV almost identically equals P / Px Target. To this point, Price / Px Target serves as a proxy for P / NAV, with some analysts choosing to discount or haircut their price target by a factor (maybe 10%) of NAV due to their belief that certain constraints will keep them from realizing their projected Net Asset Value.
Thanks for the knowledge
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