3 Key Ratios to Use When Hunting for Value in Canada’s Oil Patch

Evaluating the metrics to value Canadian energy stocks — and picking a few that look attractive at today’s prices.

The Motley Fool

Fellow Fool Robert Baillieul’s recent article, “What’s Best of Breed in the Oil Patch?” raised some interesting questions about how to value oil companies. Robert’s conclusion was that the best valuation measure is return on capital employed (ROCE) — a metric he favours over the standard measures in an investor’s tool kit such as the price-to-earnings or price-to-book-value ratios.

Notwithstanding that this is a useful measure of value, I believe investors must also look at a range of other industry-specific ratios — particularly those that measure an oil company’s value in comparison to its oil production, profitability, and oil reserves.

The simplest of these ratios, which allows for an apples-to-apples comparison, is the enterprise value-to-EBITDA ratio. It takes into account a company’s assets and debt (i.e., enterprise value) and then divides it by its earnings before interest, tax, depreciation, and amortization.

This ratio is superior to using the price-to-earnings or price-to-book-value ratios because it is capital structure neutral (because it includes debt). EBITDA is also a better measure of a company’s core profitability because it measures profitability before the impact of interest and debt repayments. It also removes the distortive effects of the taxation policies of individual countries.

So the enterprise value-to-EBITDA ratio is a more appropriate measure for comparing companies that have different degrees of leverage and capital structures, with a variety of operations across different tax jurisdictions.

More considerations
Two other key measures used to evaluate oil companies: enterprise value-to-barrels of oil produced daily and enterprise value-to-oil reserves.

The first ratio allows investors to determine whether a company is trading at a discount to its peers, while the second measures how well a company’s oil assets will support its operations. (In the case of both, like enterprise value-to-EBITDA, the lower the value, the cheaper the company.)

When looking at the table below, these ratios tell a far different investing story than using standard measures such as price to earnings ratio or price to book value.

Company Type of Company Enterprise Value (EV) EV-to-EBITDA EV-to-Bbls Daily ($’000) EV-to-Reserves P/E P/ BV
Suncor Integrated O&G $60B 5 $113 14 20 1
Canadian Nat Res Integrated O&G $46B 7


$72 9 25 1
Imperial Oil Integrated O&G $43B 9 $152 12 11 2
Husky Energy Integrated O&G $32B 6 $99 26 13 1
Cenovus Large Cap Independent E&P $29B 7 $168 13 37 2
Talisman Large Cap Independent E&P $17B 8 $48 16 350 1
Pacific Rubiales S/Mid cap Independent E&P $9B 16 $62 23 30 2
Athabasca Oil S/Mid cap E&P $2.6B -101 $347 40 11 1
Whitecap Resources S/Mid cap E&P $2.2B 11 $122 36 35 2
Gran Tierra Energy S/Mid cap E&P $1.7B 3 $71 41 11 2

Sources: Yahoo Finance, Company Filings, YCharts.

As the chart illustrates, the standout performer on the basis of enterprise value-to-EBITDA is Suncor (TSX:SU) (NYSE:SU), indicating that the market has yet to recognize the strength of its core profitability.

But on the basis of enterprise value-to-reserves, the standout candidate is Canadian Natural Resources (TSX:CNQ) (NYSE:CNQ), which suggests that the market has yet to fully recognize the value of its oil reserves. Imperial Oil (TSX:IMO)(NYSE:IMO) is also attractively valued on the basis of this ratio.

All three companies are strong contenders for investors because they have considerable oil reserves, strong core profitability, and, in comparison to their peers, they appear undervalued.

They also appear far better value for investors on the basis of their enterprise value-to-EBITDA, oil reserves, and barrels of oil produced daily than many of the smaller companies listed. This is because as integrated oil and gas majors, they are able to access greater economies of scale and utilize their downstream operations to hedge against wider price spreads.

They also have considerably larger resource bases, minimizing their exposure to the risks that come with investing a considerable portion of financial resources in exploration and development. Investors only need to look at Athabasca Oil’s valuation ratios to see the impact that high capital expenditures on exploration and development with low production has on a small-cap oil explorer and producer.

Foolish final thoughts
There is no one magic ratio that allows investors to readily determine if a particular company is undervalued. Investors need to ensure that they not only consider a range of rations but that they choose those metrics that allow for apples-to-apples comparisons.

Canada = fueling a global shift in energy
Looking for a specific stock idea from the energy sector? The Motley Fool Canada’s senior investment analyst has hand-picked two of his favorite in Canada. Download your copy of this Special FREE Report, “Fuel Your Portfolio With This Energetic Commodity,” by clicking here!

Disclosure: Matt Smith owns shares of any companies mentioned.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Investing

Businessman holding AI cloud
Tech Stocks

2 Stocks That Could Grow Your Portfolio Over the Next Decade

These two TSX stocks could be stellar additions to your long-term portfolio, given their multi-year growth potential and discounted stock…

Read more »

Wireless technology
Tech Stocks

These Tech Stocks Are Growing up to 138% Despite the Recession

Growth stocks like WELL Health Technologies (TSX:WELL) are thriving, despite the recession.

Read more »

close-up photo of investor Warren Buffett
Stocks for Beginners

New to Investing? Here’s 1 of Warren Buffett’s Most Important Quotes

As market uncertainty continues to intensify, here's some advice from the Oracle of Omaha to help you navigate this environment.

Read more »

data analytics, chart and graph icons with female hands typing on laptop in background
Dividend Stocks

Want Easy Passive Income? Go With These 3 Canadian Dividend All-Stars

Are you looking for easy passive income? Here are three Canadian dividend all-stars.

Read more »

Man data analyze

3 of the Top-Growing Stocks on Earth

Canadians desperate for growth in a shaky market may want to look to growing stocks like Cardinal Health Inc. (NYSE:CAH).

Read more »

Nickel ore is mined from the ground.
Metals and Mining Stocks

Offset Market Volatility With a Shiny Investment

Looking to offset market volatility with a shiny investment you can hold for the long-term? Here’s a precious option to…

Read more »

grow dividends
Tech Stocks

BlackBerry (TSX:BB) Stock: The Best Buy for Your RRSP

BlackBerry stock is still falling after its quarterly result, despite a 28% revenue increase in its Internet of Things segment.

Read more »

green energy
Dividend Stocks

These Monthly Dividend Payers Could Carry Your Portfolio for Years

Building a portfolio takes years. Without further ado, invest in these monthly dividend payers and start earning.

Read more »