As you’d expect, many people think energy stocks are fully valued, if not excessively valued, after their big run. The S&P/TSX energy sector has gained 411% since 1999.

There aren’t any bargains left. Or are there? To estimate value and future growth, analysts have a variety of ways to slice through oil company data. Some are strictly oil and gas industry insight, others are methods of analysis that apply to any company or stock. The tables here show what some analytic approaches say about the largest-capitalization oil and gas stocks in the S&P/TSX energy index. By one measure you find what appears to be a bargain, but by another the “bargain” looks not so appealing.

One set of measurements are basic to any stock: return on equity, earnings growth rate, and price relative to shareholders equity (book value). In the table on the left, all stocks reveal above-average profitability, except for start-up Western Oil Sands (which counts its operating life in months) and most have had superior profit growth. Note the relatively low price/book value for Canadian Natural Resources and EnCana Corp., the big exploration and production market leaders.

Exceedingly fast growth also distorts analytical results. This is particularly so for PetroKazakhstan and Niko Resources.
These two have been the meteors of the energy sector, and by some measures shown here, their prices have outrun expected value.

Though Canadian companies, their common feature is foreign operations. They operate in Asia, with little or no presence in the Canadian oil patch. Their earnings growth rates are almost off the scale, and that has resulted in high stock prices relative to book value.

Estimating the value of a fast-growth
company is the purpose of the “intrinsic value” figures in the middle table. This method is used by Benjamin Graham, founder of investment analysis. The challenge is to guess how fast a company will grow in the next few years. We show two conservative estimates of growth — 10% a year and 15% a year — using three-year average earnings as the calculation’s starting point. Analytical measurements tend to be truer for longer established and larger concerns, but they are not always flattering.
So Imperial Oil shows up poorly in its stock price relative to expected future production (sometimes described as the “standardized measure of discounted future net cash flows from proved reserves.”)

To its credit, Imperial is alone among the big integrated companies in reporting this figure. As the country’s leading refiner and marketer of petroleum products — a more diverse set of businesses than exploration and production operations — Imperial’s future does not rest on its production alone.

This statistic attempts to sum up the cash a company might generate in the future from its current oil and gas reserves. The figure is especially significant for exploration and production companies. As the figure is a projection based on a series of estimates, don’t be surprised at any variance in future performance.

The table on the right shows the discounted cash flow measure used by Warren Buffett to evaluate companies. The starting-point is each company’s recent actual cash flow.

Because of fast industry growth in the past year, we have heeded Graham’s advice to use averages when analysing a company’s results. So free cash flow for the past three years has been averaged for the basis of the calculation, which projects ahead 10 years.
Estimated future growth rate is 15%.

Several companies have not generated free cash flow (cash flow after capital spending and dividend payments) in recent years. But investing in property and equipment is essential for E&P companies, even if they don’t always generate enough cash for the job. After all, it’s easy for them to raise new money these days. IE