Andrew at City of God has posted that the Watcher called into question Sue Richard’s calling the Silver Surfer all powerful: “‘all-powerful? There is only one who deserves that name! And his only weapon… is love’ (Fantastic Four #72; Mar. 1968).” Well for us investors, we worship at the feet of one and only one, his high and mightiness, Benjamin Bernanke, the chairman of the Federal Reserve Bank. He is the one who determines what our assets are worth and he wields a weapon called “QE” and another called interest rates with which he increases our power, our net worth, and we become mighty warriors of investing–but when he refrains from wielding them, suddenly we are all grovelling in the dirt like worms eating skubala (a.k.a., the margin call).
So I wrote to my good friend Mich at Beating the Index, who is fretting about running out of powder for his battle on the investment front:
Bernanke is the first cause of everything in the market today. He is exercising his omnipotent power as head of the Federal chair to influence risk appetite. Well, there will be either more monetization soon or watch hundreds of thousands of government workers in Washington not get their pay cheques and be sent home crying. My Schadenfreude would be so high at that point, it would almost be worth a 50% cut in my portfolio to see it. But it ain’t never gonna happen! Believe me, by August or September, the pols in Washington are going to lose nerve and there will be new debt ceiling (and QE3), based upon a compromise between the left-wing republicans and the democrats in the House.
Meanwhile, fear is palpable. The companies in which I am invested have increased their asset values through the development of oil fields but their share prices are way down because the lack of QE3 has diminished risk appetite. People are rightly afraid to be caught with their margin pants down, like what happened to silver investors when the margin requirements were magically increased.
Devon Shire chides Petrobank (last $14.30)/Petrobakken (last $13.63) for not having a share buyback at these low prices, which puts their market capital at serious multiples below the Net Present Value. Shire wants them to reward shareholders with a buyback of shares, but of course the management spent that cash on PBN shares starting at $21 and who knew that the price would plummet to these levels? These prices are not only at multiples below NPV but well below book value (=shareholder’s equity). I wrote to Mr. Shire the following response:
Net Present Value for other junior and intermediate companies is also currently at extremely high ratios to market value. Midway Energy is reporting NPV10 of 1.7 billion while its market capital is 274.9 million.
Some are angry with Petrobakken for continuing what they consider to be an ill-advised dividend program. Evidently, the buy back of shares is an equivalent use of cash as a dividend–I suppose that the real need is to spend money on developing their resources in order to deliver growth. The sad part is that PBN started the repurchase program at $21 while the price was so high vis-a-vis the current price.
At some point either you and I are going to be considered really stupid for thinking we had found value in the Canadian oil sector, or there is going to be a major correction drastically decreasing the NPV/market capital ratio.
Yet Mich warned me about taking the NPV10 that Midway had presented as a serious indicator of their value and I reproduce here our dialogue:
Petros: What do you make of NPV10 (Net Present Value 10% discount)? What do you think that the discount to NPV10 should be when buying a junior oil. I am looking at Midway energy now and the NPV10 (on just Cardium and Swan Hills) is 1.6 billion. So the NPV10 per shares (fully diluted) is about $19.30 or 4.7 x current market price. Is NPV10 a reasonable means of determining the fair market price of a junior oil? Just picking your brain, I hope you don’t mind.
Mich: While NPV10 gives you a snapshot on the upside of a stock it ignores several factors such as the need to raise money along the way and commodity prices which are directly linked to the global economy. I would not use the multiple you mentioned for evaluation purposes as too many uncertainties are unaccounted for.
Petros: Thanks Mich: that’s a great answer, and yet I am not totally satisfied. For one thing, the oil assets begin to pay for themselves when income from operations goes up because of successful drilling and sufficiently high commodity prices.
Obviously, companies like to promote their NAV or NPV because it gives people an idea of the worth of the company. The investor has to decide whether they have the time to allow the money mature over time. If you or I have a five to 25 year time horizen, that is very different than the investor who is saving to buy a house in the next three years. Yet, I would rather have a share in 1.6 billion dollar asset as opposed to owning a lot of debt with no assets. Look at the Saudis or Dubai and their Arab sheiks who have owned assets that could consistently produce oil over time, and they have become very rich and in many cases indolent in their oil wealth.
Oil prices will go up and down, though some think that we’ve seen the last of cheap oil, for reasons of increasing demand and diminishing supply (sometimes called Peak Oil). I think that it has a lot to do with the devaluation of currencies–and for that reason I see oil companies as safer than bonds.
So I ask again, if MEL NPV10 is $19.30, then what is the fair market value? What should a company like that be selling for at this point? I think it is over sold at $4.05, and some are saying that the price may be $15.00 or more in two years. Certainly a price closer to $7-10 would be more reasonable when the NPV10 is $19.30–or ?
Mich: NAV and NPV are 2 different things. NAV is the current value of the company (reserves + land + etc…) while the NPV10 in your case is for the undeveloped locations that MEL has. The NPV10 is the expected future cashflow discounted by 10% in today’s money (the upside of the stock).
There is no such thing as fair market value when you are on the brink of a second recession. The market right now is irrational so there’s no good answer. It would be nice to watch an oil weighted transaction right now, this will give us a very good idea on where MEL should be trading based on the numbers.