Top 5 Trading Multiples for Oil and Gas Company Valuation

Oil and gas industry analysts often use five key trading multiples to value companies and assess investment opportunities. These are EV/EBITDA, EV/BOE/D, EV/2P, Price/Cash Flow Per Share, and EV/DACF. They provide insights into a company’s financial performance and efficiency relative to its peers. Analysts rely on these measures to compare companies within the sector, helping investors make informed decisions about where to allocate capital.

Understanding EV/EBITDA in Oil and Gas Valuation 

The first multiple we’ll look at is EV/EBITDA—enterprise value compared to earnings before interest, tax, depreciation, and amortization This multiple is also referred to as the enterprise multiple.

A low ratio indicates that the company might be undervalued. It is useful for transnational comparisons as it ignores the distorting effects of different taxes for each country. The lower the multiple the better, and in comparing the company to its peers, it could be considered undervalued if the multiple is low.

The EV/EBITDA ratio compares the oil and gas business—free of debt—to EBITDA. This is an important metric as oil and gas firms typically have a great deal of debt and the EV includes the cost of paying it off. EBITDA measures profits before interest. It is used to determine the value of an oil and gas company. EV/EBITDA is often used to find takeover candidates, which is common within the oil and gas sector.

Exploration costs are typically found in the financial statements as exploration, abandonment and dry hole costs. Other non-cash expenses that should be added back in are impairments, accretion of asset retirement obligations, and deferred taxes.

Advantages of EV/EBITDA

One of the main advantages of the EV/EBITDA ratio over the better-known price-earnings ratio (P/E) and the price-to-cash-flow ratio (P/CF) is that it is unaffected by a company’s capital structure. If a company issued more shares, it would decrease the earnings per share (EPS), thus increasing the P/E ratio and making the company look more expensive. But its EV/EBITDA ratio would not change. If a company is highly leveraged, the P/CF ratio would be low, while the EV/EBITDA ratio would make the company look average or rich.

Using EV/BOE/D to Measure Oil Production Value 

This is enterprise value compared to daily production. Also referred to as price per flowing barrel, this is a key metric used by many oil and gas analysts. This measure takes the enterprise value (market capitalization + debt – cash) and divides it by barrels of oil equivalent per day, or BOE/D.

All oil and gas companies report production in BOE. If the multiple is high compared to the company’s peers, it is trading at a premium. If the multiple is low amongst its peers, it is trading at a discount.

As useful as this metric is, it does not take into account the potential production from undeveloped fields. Investors should also determine the cost of developing new fields to get a better idea of an oil company’s financial health.

The Role of EV/2P in Assessing Oil Reserves

This is enterprise value compared to proven and probable reserves (2P). It’s an easily calculated metric which requires no estimates or assumptions. It helps analysts understand how well its resources will support the company’s operations.

Reserves can be proven, probable, or possible reserves. Proven reserves are typically known as 1P. Many analysts refer to it as P90, or having 90% probability of being produced. Probable reserves are referred to as P50 or having a 50% certainty of being produced. When used in conjunction with one another, they are referred to as 2P.

The EV/2P ratio should not be used in isolation, since reserves are not all the same. However, it can still be an important metric if little is known about the company’s cash flow. When this multiple is high, the company would trade at a premium for a given amount of oil in the ground. A low value would suggest a potentially undervalued firm.

EV/3P can also be used. That is proven, probable, and possible reserves together. However, as possible reserves have only a 10% chance of being produced it is not as common.

Evaluating Companies With Price/Cash Flow Metrics

Oil and gas analysts often use price compared to cash flow per share or P/CF as a multiple. Cash flow is simply harder to manipulate than book value and P/E ratio.

The calculation is simple. Take the price per share of the company that is trading and divide it by the cash flow per share. To limit the effects of volatility, a 30-day or 60-day average price can be used.

The cash flow, in this case, is the operating cash flow. That number does not reflect exploration expenses, but it does include non-cash expenses, depreciation, amortization, deferred taxes, and depletion.

This method allows for better comparisons across the sector. For the most accurate results, the share amount in calculating cash flow per share should use the fully diluted number of shares. One disadvantage of this method is that it can be misleading in case of above average or below average financial leverage.

Assessing Cash Flow With EV/DACF in the Energy Sector

This is EV/DACF—enterprise value compared to debt-adjusted cash flow. The capital structures of oil and gas firms can be dramatically different. Firms with higher levels of debt will show a better P/CF ratio, which is why many analysts prefer the EV/DACF multiple.

This multiple takes the enterprise value and divides it by the sum of cash flow from operating activities and all financial charges including interest expense, current income taxes, and preferred shares.

The Bottom Line

EV/EBITDA, EV/BOE/D, EV/2P, Price/Cash Flow Per Share, and EV/DACF allow investors to compare financial health, efficiency, and growth potential across different firms, providing a clearer picture of investment opportunities. Each multiple has its own strengths and limitations, so they are most effective when used together as part of a broader analysis. By considering these ratios, you can make more informed decisions in the energy sector.