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1.4¢ elk petroleum limited

Good morning Dan, Well done with researching what I attempting...

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cmonaussie

6,312 Posts.

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16/04/17

08:03

Post #: 24088098
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Originally posted by danpech ↑

Hi cmon

Thanks for your great response, like I said, you are one of the best.

I agree with your supposition we are looking at the same thing in a different manner in regards to FCF and after reading your post I think we are pretty well on the same page.

After all, the FCF of a company is the sum of the FCF of the individual assets so I do like to see what an individual asset throws off in cash within a portfolio as ascertaining the powerhouses as compared to under performers provides more clarity in analysing companies IMO. Obviously as you said the more assets/ projects in the larger companies makes this impractical but is pretty straight forward in a company like ELK.

In all honesty I hadn't heard of the RESIDUAL EARNINGS before and all I can say is if you value/ analyse your stocks by these methods then you must be some sort of genius.

For those others on the thread still reading I'll try to put up a simplified explanation.

1) RESIDUAL EARNINGS are defined in terms of equity valuation as the income generated by a firm after accounting for the true cost of capital...... sounds reasonable but what is the true COST of CAPITAL.

2) COST of CAPITAL depends on how the company is funded. If funded by debt then this is COST of DEBT.... If it is funded through equity then there is a COST of EQUITY.

Most companies are funded through both so you need to find the combined costs of both also known as the WEIGHTED AVERAGE COST OF CAPITAL or WACC.

To do so you need to consider the CAPITAL STRUCTURE of the company, for example if it is funded 60% by equity and 40% by debt then the WACC is the sum of the COST of EQUITY x 0.6 and the COST of DEBT x 0.4.

The COST of DEBT is total interest paid divided by total debt which for arguments sake will be 7% and this is pre tax.... to get the post tax figure you need to subtract the effective tax rate from 1 , and multiply the difference by the COST of DEBT.

are you still with me?

and we haven't worked out the COST of EQUITY yet but after completing your friggin accountant,s degree lets say it came out to be 11 %

So finally we get the WACC as (0.6 x 11%) + ( 0.4 x 7%) = 6.6% + 2.8 % or 9.4% PHEW ?

OK , now to the RESIDUAL EARNINGS calculation, should get pretty easy from here

BUT, ... here we go again .. in calculating a firm's RESIDUAL INCOME the key calculation is to determine its EQUITY CHARGE. WTF #@&% .. I'll might as well just blow my brains out right now

EQUITY CHARGE is simply a firm's total equity capital multiplied by the required rate of return of that equity,

or Equity Charge = Equity Capital x Cost of Equity

We have calculated the Cost of Equity at 11% , we are given the Equity Capital in the balance sheet etc,etc,etc

Read more: Valuing A Company Using The Residual Income Method http://www.investopedia.com/articles/fundamental-analysis/11/residual-income-model.asp#ixzz4eKYUiSah

As I said Cmon, if you do this then you are a accountancy guru and I bow down to you!

Your ELK exercise, mostly it will have to wait until Grieve is in production and we get a full set of financials.

However, from the presentations/ annoucements

All in cost BO (and it has to be 2p as I can't find a 1p number for Grieve ) is US$174/12.3 = US$ 14.... they say development cost is $7-10 so we have acquistion and pre development costs of $4-7 BO

The upfront cost of purchasing the put option to provide a US $45 floor price for 75% of ELKS Grieve production for calendar 2018 and 2019 was AU$5.77 million..

Grieve operating margin (including royalties) BOE ranges from US$ 27 at a US$45 oil price to US$41 at a US$65 oil price.

Madden all in cost would be the purchase cost and is US$ 17.5/71.3 BCF and is US$0.25 MCF PDP.

Madden has production costs of US$1.6 per MCF including royalties and production taxes for( 2017-2021) and capital costs of Us$0.3 per MCF for the next five years. These do not include maintenance costs .

About the only point I disagree somewhat with is your statement that ELK is like a shale company in field development stage. basically because the Shale guys have to keep on drilling US$ 8 million + wells which typically decline at 40% per annum . Once they stop drilling their production rates fall off a cliff. They do get their money back very quickly no doubt but invariably you have to be a big boy/girl to play in that game.

Gieve's decline looks to be in the order of 5% PA or so with no further wells to be drilled once production starts. As for Madden, there are no plans to drill a deep well ( US$ 50 million cost) any time soon ... they will consider it if the price of gas increases substantially ( Cost of capital at work here! )

Basically, what I am trying to say is IMO ELK, due to the fact it should have low sustaining capital costs for both Grieve and Madden, will have significant free cash after corporate costs and loan amortisation (will ask about repayments at the EGM ) to fund other projects and / or return cash to shareholders.

Would be great to have you on the team here one day.

Thanks and cheers

Dan

Expand

Good morning Dan,

Well done with researching what I attempting to draw attention to. I am not an accountant - but I am a finance person (now). I actually put up a simple Residual Earnings on SSN a few weeks back now that they are into a project that is highly capital efficient. Whether they get to survive or not remains to be seen.

I wouldn't say genius ... excel makes us all look smarter than we are

Be careful not to mix things up. When doing Equity Valuation you need the Required Return on Equity cost of capital and use that. When doing Project Evaluation you would look for the WACC as a STARTING POINT for the determining the discount factor to use in NPV analysis. WACC is the overall cost of capital for the company ... so if a project does not mirror the capital structure of the company AND mirror the risk of the company's other assets then it needs to be adjusted. And since it is a project many things can be left off (e.g. corporate costs)

I'd be genuinely surprised (shocked, stunned and awed more like it) if ELK had equity cost of capital of 11%. Something else to look up is the CAPM and use of Beta. The beta value for ELK on Yahoo doesn't appear to make any sense to use. The beta for your partner DNR is 4.28 which puts the Required Return on Capital (which is used as cost of capital) at approx 32.5% .... Yep thirty two point five ... this is reflective of the risk that DNR carries (as they have been close to Ch 11 a couple of times in the past 4 years).

Enough on the corporate finance aspects ... just trying to highlight its much more complicated (and therefore riskier) than most posters think.

Again I look at Earnings... sorry but $14/BO for all in cost is not believeable. But that's OK I am not modeling ELK and when I do model these days I am looking for value creation (for the common equity shareholder) ... and that simply means how will a company earn about its equity cost of capital. Does anyone here really care about creating value for the debt holders??

Take another look at shale ... not from the perspective of a small Aussie ASX company but through the lens of say COP or EOG in the EFS and CVX and PXD in the Permian. The issue was/is/and always will be about CAPITAL EFFICIENCY.

Best of luck with ELK, may it earn above its cost of capital and deliver value to shareholders (and deliver reliably positive FCF to do what is best for shareholders ... and if that means returning cash so be it).

Regards

ELK Price at posting: 7.1¢ Sentiment: None Disclosure: Not Held
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