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Our Transition to Net Asset Value Methodology for Oil Sands Producers

We have modestly reduced the fair value estimates for our covered oil sands producers; CNRL remains a Best Idea.

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We recently shifted to a net asset value, or NAV, methodology for our oil sands producers, which extends the five-year forecast period we typically use to analyze oil and gas firms to one that we believe more appropriately captures the long development horizons and significant up-front capital requirements of multidecade oil sands projects. As a result of our updated methodology, we recently lowered the fair value estimates for our covered firms; integrated producers fell by an average of 6%, while the two nonintegrated producers on our coverage list,  Canadian Natural Resources Ltd. (CNQ) and  MEG Energy Corp. (MEG), saw their fair value estimates fall by 8% and 27%, respectively. Canadian Natural remains our most undervalued oil sands producer and a Best Idea.

Why We Have Updated Our Valuation Methodology for Oil Sands-Weighted Stocks
We believe our former approach to valuing oil sands producers is no longer optimal for capturing the value of the long-life plateau producing nature of oil sands assets. Our former oil sands valuation methodology utilizes a five-year discounted cash flow, or DCF, approach that incorporates an EBITDA multiple-based terminal value. It is in the estimation of the terminal multiple where we believed our methodology could be improved: Given the volatility of market prices and earnings in the oil sands space over the last several years, determining a terminal multiple that accurately reflects the long-term cash flow-generating ability of these projects has proved difficult. By using a net asset value, or NAV, approach, we eliminate this issue.

David McColl does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.