Oasis Petroleum Inc. Wenjun Wu
- 1. Wu 1 Oasis Petroleum Inc. Part I: Discounted Cash Flow Valuation Based on data from 2010-2014, Oasis Petroleum Inc. (OAS) is in a high growth stage these years and the growth rate is declining. The two-stage growth model will be a good model to value it. Since it is a high-growth firm with great potential, 10 years will be an appropriate length of the high-growth period. After that, the company will go to stable stage, and the stable growth rate is 3%, which is similar to the whole economic growth rate in U.S. The Sales/Capital ratio in the stable stage is 1.07. (Reinvestment = (Revenue t+1 – Revenue t) / (Sales/Capital)) The reinvestment rate in the stable stage is 20.28%, which is calculated by Reinvestment / EBIT (1- T). The ROIC in the stable stage is 14.79%, which is calculated by Expected Growth Rate of EBIT / Reinvestment Rate. The pre-tax operating margin in the stable stage is 22%, which is equal to the average pre-tax operating margin in the industry. The tax rate in the stable stage is 39%, which is equal to the general marginal tax rate for corporations in U.S. The cost of capital in the stable stage is 8.44%, which is equal to the average cost of capital in the industry. The key drivers of value for OAS are growth rate and pre-tax operating margin. The estimated value is very sensitive to the changes in the assumptions of stable growth rate and stable pre-tax operating margin. For other assumptions, the estimated value is not very sensitive to their changes. The Discount Rate in the valuation is cost of capital. To construct it, cost of debt, cost of equity, debt ratio, and equity ratio are needed. For remaining market neutral, the risk free rate is 3%, and the market equity risk premium is 5%. After estimating synthetic rating by fixed charges coverage ratio, it is easy to find that the corresponding default spread is 2%, so the cost of debt is 5%. The after-tax cost of debt is 3.11% by using effective tax rate in 2014 (37.78%). Using unlevered beta in Petroleum industry and estimating debt to equity ratio, the levered bottom-up beta is 2.40. (Assume βD=0) The cost of equity is 14.98%. The amount of debt and the number of shares outstanding are from the company’s 10-Q in 2014. The market price per share is $26.55. Debt includes short-term and long-term capital lease obligations, long-term debt, and the capitalized value of operating lease obligations. (Assume BV of Debt = MV of Debt) Calculating weights of debt and equity, then, the cost of capital is 9.10%. This company doesn’t have R&D, employee stock options and warrants, minority interests, and cross-holdings. The only three things needed to deal with are tax rate, operating leases, and stock-based compensation expenses. For tax rate, the main formula is Tax Rate=Tax Expense / (Tax Expense + Net Income). By using tax expense and net income in 2011, 2012 and 2013, it is easy to get effective rates in these years are 37.08%, 37.62%, and 37.20% respectively. In 2014, trailing tax expense and net income are used to calculate effective tax rate, which is 37.78%. Since the general marginal tax rate for corporations in U.S. is 39%, it is better to assume that tax rate for the company will move close to 39% and continue forever.
- 2. Wu 2 For operating leases, since the specific information about operating leases is provided in 10-K in 2013, adjusting operating income in 2013 may be a good idea. Allocating operating leases to each year and discounting them by cost of debt, the present value of operating leases is $9,850. Doing straight-line depreciation, the depreciation in 2013 is $1,970. The adjusted operating income in 2013 is $597,062. (2013 Adjusted Operating Income = 2013 Operating Income + Operating Lease Expenses – Depreciation) For stock-based compensation expenses, it is better to subtract it from value of equity. Therefore, the value per share is $29.03. (Value per Share = (Value of Equity – Stock-based Compensation Expenses) / Common Shares Outstanding) Part II: Relative Valuation (Comparables) EV/Sales ratio is the multiple using in comparing firms across the group. Reason: Firms in Oil/Gas (Production and Exploration) industry lack information about PE, PEG, PBV, and PS. For example, there are only 11 firms have Current PE, and only 4 of them have Expected Growth Rate in EPS. As for EV/EBIT, EV/EBITDA, EV/Invested Capital, and EV/Sales, the adjusted R2 for their regressions are -11%, 68%, 1%, and 90%, respectively. Therefore, the EV/Sales ratio is the best choice. Description: The mean and median of EV/Sales are 8.17 and 7.36. Since the mean is larger than the median. The distribution of EV/Sales is skewed to the right. EV/Sales ratio of OAS is 10.16, which is larger than the mean and the median, so it is overvalued. Predicting OAS’s price per share by mean, median, minimum, and maximum, it can be concluded that OAS’s price per share will fall in range of $33.40~$80.83 (mean) or $27.86~$80.83 (median). Since the median is often a more reliable comparison point, the better estimated range may be $27.86~$80.83. Analysis: Constructing XY scatterplots of EV/Sales & After-tax Operating Margin, EV/Sales & Reinvestment Rate, EV/Sales & Beta, and EV/Sales & Expected Growth Rate, it is obvious that EV/Sales & After-tax Operating Margin and EV/Sales & Expected Growth Rate have positive relationships. As for EV/Sales & Reinvestment Rate and EV/Sales & Beta, there are no significant relationships showing in the XY scatterplots. Peer Group Regression: The regression of EV/Sales with After-tax Operating Margin, Reinvestment Rate, Beta, and Expected Growth Rate has adjusted R2 of 90%. Based on the analysis before, it seems like that the regression can be improved by running with only After-tax Operating Margin and Expected Growth Rate. The regression of EV/Sales with After-tax Operating Margin and Expected Growth Rate has adjusted R2 of 92%. Even though it is not improved a lot, the regression of EV/Sales with After-tax Operating Margin and Expected Growth Rate is still a better model for predicting EV/Sales. This model shows that both of After- tax Operating Margin and Expected Growth Rate have significantly positive relationships with EV/Sales, and OAS is overvalued. The predicted EV/Sales ratio for OAS is 9.73, so the predicted price per share for OAS is $44.05.
- 3. Wu 3 Market Regression: EV/Sales = 0.78 + 5.24 g + 7.12 Operating Margin + 5.39 DFR - 0.67 Tax Rate (DFR is Debt Ratio) This regression shows that EV/Sales ratio has significantly positive relationships with Expected Growth Rate in Revenue, Pre-tax Operating Margin, and Debt Ratio, and EV/Sales ratio has significantly negative relationship with Tax Rate. The predicted EV/Sales ratio for OAS is 8.16, which shows that OAS is overvalued, so the predicted price per share for OAS is $33.32. Part III: Estimated Values and Recommendation Oasis Petroleum Inc. (OAS) Valuation Method Price per Share OAS DCF $29.03 Mean $33.40~$80.83 Overvalued Median $27.86~$80.83 Overvalued Peer Group Regression $44.05 Overvalued Market Regression $33.32 Overvalued Current Stock Price $26.55 11/14/2014 Based on the relative valuation, the price per share for OAS should be in the range of $27.86~$44.05. Since the data for relative valuation was updated in January 2014, it can be concluded that the stock price for OAS at the beginning of 2014 was overvalued. The overvalued situation began to be disappearing after OAS reached its highest stock price $58.09 in July 2014. The current stock price for OAS is $26.55, which is lower than $27.86. It seems like that the market overly corrects its mistakes. Beyond that, in terms of the discounted cash flow valuation, which includes the most up-to-date data, the value per share for OAS should be $29.03. Therefore, the current stock price for OAS is underpriced to some extent. Based on this analysis, betting on OAS will be a good choice.