Hart House Investment Club
Nikola Mitrovic
Net Asset Value (NAV)
July 2015
Introduction to Net Asset Value
Valuation technique that determines a share price
for a company, based on the company’s assets and
their future production or cash flows.
Usually used to value companies in
resource/commodity based industries:
Ex: Oil and Gas, Metals and Mining.
Why Use a NAV over DCF Analysis?
Key assumption in a DCF is that the target company
operates in perpetuity (Hence, terminal value)
However, for an exploration and production (E&P)
company, that is not possible – there is a finite
amount of resource in the ground.
An E&P company can only operate when there is
something to extract.
It follows that the company ceases to exist when all of
its resource reserves are depleted.
Key Assumptions
Company operates until it runs out of reserves
No exploration – No new reserves
Declining production rate
Only expenses at the asset level are included:
Expenses related to production.
Expenses related to asset development
The rest can be considered “overhead” – company
level.
Assumption Implications
No new reserves implies no exploration expenses.
Development of assets and production expenses
are the only two accounted.
Others such as SG&A, non cash expenses
(depreciation) are not included.
Only expenses tied to production.
Step 1: The Operating Model
Forecast each of the financial statements:
– Statement of Comprehensive Income
– Statement of Financial Position
– Statement of Cash Flows
Include commodity prices, reserves and yearly
production forecasts.
Note: No special treatment for these forecasts
– Include all the expenses, even exploration despite
assumptions.
Step 2: Revenue
Revenue is projected based on the company’s
production and the estimated average commodity
price for that year.
– i.e. 5 MMBoe at $50/Bbl = $250 Million revenue
Revenue projections are calculated until the
company’s reserves run out.
Yearly production should be declining, as reserves
are depleted.
– i.e. 5% declining rate
Step 3: Expenses
Expenses related to the asset are included (Asset level
vs. Company level)
This includes any expenses related to production.
Both production and development expenses are
applied.
Non-cash expenses are not included.
Ex: SG&A is a company level expense, and usually
considered “overhead”. It is hard to directly attribute
these expenses to a specific asset. Therefore they are
removed.
Step 4: Taxes and Discounting
Assume a tax rate and discount rate.
Find the after tax revenues for each year.(1-T)
Discount the after tax revenues to the present.
– i.e. After-Tax Revenue/(1+WACC)^n
Sum to get the Present Value of after-tax future
cash flows.
Step 5: Other Assets and Segments
Other assets is usually made up of undeveloped land.
An oil/gas company may have other businesses, such
as chemical or pipeline businesses.
These values are usually estimated based on $/acre or
an EBITDA multiple. Ex:
– 20,000 acres x $2500/acre = $50 million
– EBITDA = $2 million. EV/EBITDA = 4.2x
– Business Segment Value = $8.4 million
Add these to the PV of future cash flows, giving the
Enterprise Value.
Step 6: Balance Sheet Adjustments and
Implied Share Price
Do the necessary balance sheet adjustments to
arrive at the Equity Value.
To go from Enterprise Value to Equity Value:
– Add: Cash and other Investments
– Subtract: Debt
– Subtract: Preferred Shares
– Subtract: Non-controlling interest
Calculate fully diluted shares outstanding
Implied Share Price = Equity Value/Shares o/s
Summary
Used for companies with resource based
operations.
Assumes that the company exists while there are
reserves to be extracted.
No exploration expenses and no new reserves.
Production and development expenses make up
bulk of expenses.
Other assets and business segments are also taken
into account.