When it comes to the oil and gas industry, assets matter a lot. For companies operating here, there's nothing more important than reserves, rigs, submersibles, and refineries. However, these assets must be capable of generating profitable returns.
Value for money
These returns indicate whether a given company has the capability of using its assets efficiently and profitably. After all, it makes little sense for an exploration and production company to have a lot of acreage, but not the ability to pull out the oil (or natural gas for that matter) within. In short, it pays to find out how valuable these assets are to the company.
Here, we will find out whether a given company's assets are profitable and efficient compared to its peers based on some important metrics:
- Return on assets, or net income divided by total assets, shows how much the company is earning compared against the assets it controls. The ratio is an indication of how effectively the company is converting the money it has invested in reserves, property, and other equipment into net earnings. The higher the value, the more profitable the assets are. The metric is pretty useful when used as a comparative measure -- against peers and also against the industry in general. A value greater than 5% is what investors should ideally be looking for in this industry.
- Fixed-asset turnover ratio, or revenue divided by total fixed assets (like plant, property and equipment). Fixed assets form a major chunk of total assets for companies in this industry. This metric shows how efficiently the company is using its fixed assets to generate revenue. The higher the turnover rate, the better. A value of 0.5 is about average.
- Total enterprise value/discounted future cash flows shows how expensive the company is when compared against its standardized future cash flows. The denominator indicates the total present value of estimated future cash inflows from proven reserves, less future development and production costs, discounted at 10% per annum. It's based on today's energy prices and doesn't give any credit for unproven reserves.
With these factors in mind, let's take a look at Linn Energy
|
Company |
Return on Assets |
Fixed-Asset Turnover Ratio |
P/B |
TEV/DFCF |
|---|---|---|---|---|
| Linn Energy | (0.7%) | 0.2 | 2.19 | 2.26 |
|
Cabot Oil & Gas |
2.5% | 0.2 | 3.70 | 3.05 |
|
Concho Resources
|
5.4% | 0.3 | 3.15 | 2.46 |
|
Enerplus |
3.7% | 0.2 | 1.34 | 1.97 |
Source: Capital IQ, a Standard & Poor's company; company filings.
Linn Energy's assets don't seem to generate great returns when compared with its peers and the industry at large. Its fixed-asset turnover is among the weakest as well. However, investors must note that derivative losses have played a substantial role in these weak returns.
Average production actually rose by 40% in the first six months of the year compared to the corresponding period in 2010. Operationally, the results don't look too bad. Keeping these figures in mind, I think the stock is fairly priced against its book value and reserves.
Foolish bottom line
This isn't the only criterion you can use, although assets generally indicate how oil and gas companies have been faring in terms of operations. You can get a more comprehensive understanding by digging deeper, but Linn Energy seems about fairly valued.
If you'd like to stay up to speed on the top news and analysis on Linn Energy, add it to My Watchlist.
