Impact of '08 Impairments on Year End '09 Perceived Value of Oil and Gas Producer Stock Prices
Thursday, September 10, 2009 | Merlin Is this Spam?I nearly swallowed my dumb-dumb today when my favorite stock guru indicated that he was bearish on oil stocks. While I agree that the charts support his position I see other factors that call for a different conclusion.
The first is the simple fact that the current administration needs $100 to $150 oil to rationalize wind and solar power economics. So, I expect intermediate term policies to drive crude to these levels. While that may prompt usurious taxes once those levels are achieved, every extra dollar goes straight to the bottom line until those taxes are imposed.
If a production company’s operating cost were $50 a bbl at $55 and yielded $5 per share net income at that level, it would generate $50 per share net income at $100 oil. At a PE of 10 that stock price should skyrocket from $50 per share to $500 per share. This is simplistically overstated but the point is that increased crude prices could result in exponential perceived value growth as 2009 earnings are released.
There is one other aspect overlooked by even those who are bullish on O&G producers. That is the reserve impairments that most Oil and Gas producers absorbed in their 12/31/2008 financial reports. Typically this required them to write down proven and probable reserves to around $30 a BBL. This year the value of reserves will again be adjusted and likely will reflect $70 to $90 crude prices. Since most companies unproduced reserves amount to 5 to 10 years future production this adjustment had a huge negative effect on most producer's bottom lines last year.
While the impact will not universally impact all producers, I considered two mid majors.
1) One reflected a loss of $3.57 per share for ’08 of which $5.22 was attributable to impairment of reserves. Without impairment they would have reflected a $1.64 per share income. For argument sake assume that $1.64 might be net income for 2009 before adjustment for impairment and assume that a $70 range crude price exists at 12/31/2009, last year’s impairment would become this year’s income resulting in $6.86 per share net income for 2009. Today the stock closed at $9.38, considerably less than a 10 PE would value it at.
2) The second reflected a 2008 profit of $1.45 per share after impairments of $5.40 per share. Absent impairments this stock would have earned $6.86 per share. Again assume that last years impairment is added back to this year’s income and 2009 earnings would be $12.26 per share. This stock today closed at $27.74 or a potential PE of only 2.26.
My point is that even without further increase in the price of Crude before 12/31/2009 there is probability that the market will favorably adjust the price of many oil and gas producers by the time that year end earnings are released.
Charts reflect the consensus of the market at any given moment. I would suggest that there is ample reason to predict a consensus for oil and gas producers that is excessively higher than today 4 months from now.
Merlin Klotz
