Classification, Key Ratios, Stock Movements, Recent Announcements And WACC Of Oil Search Limited

Description of company

Oil Search Limited, the biggest gas and oil exploration companies was incorporated in the Papua New Guinea and operates under the oilfields of Papua New Guinea (PNG). The company was established in the year 1929. Under PNG, the company holds more than 98% of assets and it holds extensive exploration and appraisal portfolio. The company has clear strategy for driving the future growth. Further, the company is pursuing the opportunities for developing the additional LNG for providing trainings in PNG (Oilsearch 2017).  The company is involved for liquefying the natural gas production and the developments of it through the interest in LNG PNG projects that is operated by PNG Limited. The company has three main products; these are – gas, oil and liquefied natural gas (LNG). The company operates 3 units for the business that involves PNG gas and oil, LNG PNG products and Middle East and North America (MENA)

1. Substantial ownership

• More than 20% shareholding – no shareholders are there in the company who is holding more than 20% of shares.
• More than 5% shareholding – International Petroleum Invt. Co. PJSC (Investment Management) is holding 12.9% shares in the company and Npcp Investment Ltd is holding 9.80% shares in Oil Search Limited.

1. Name of key personnel

• Chairman –  Mr RJ Lee
• Board members
• Mr PR Botten – Managing director
• Mr G Aopi – Executive director
• Sir KG Constantinou – Non-Executive director
• Dr EJ Doyle – Non-Executive director
• Ms FE Harris – Non –executive Director
• Dr AJ Kantsler – Non-Executive director
• Mr B Philemon – Non-Executive Director
• Mr KW Spence – Non-Executive Director
• Dr ZE Switkowski – Non-Executive Director
• Mr MP Togolo – Non-Executive Ditector
• CEO – Mr PR Botten
• More than 20% shareholding – as none of the above mentioned key personnel are holding more than 5% or more than 20% shares in the company they do not fall under the category of substantial shareholders.

1. Return on assets (ROA) = (NPAT / Total Assets)

     Return on Equity (ROE) = (Net profit after tax / Ordinary equity)

      Debt ratio = Total liabilities / Total assets

EBIT/TA * NPAT/EBIT * TA/OE = NPAT/OE

EBIT/TA * NPAT/EBIT * TA/OE = 381,031/10,126,129 * 89,795/381,031 * 10,126,129/47,25,316 = 0.019

NPAT/OE = 89,795/4725316 = 0.019

From the above calculation it can be proved that EBIT/TA * NPAT/EBIT * TA/OE = NPAT/OE

1. Phenomenon of TA/OE

The phenomenon of TA/OE represents the total assets of the company as compared to it’s to its owner’s equity or ordinary equity. It stats the exposure of the company towards the risk of insolvency and measures the shareholder’s risk exposures as compared to the company’s total assets. If the company’s total assets reduce, it will increase the return on assets whereas if the total assets of the company go up, it will reduce the return on assets of the company (Naser et al. 2013). The value and importance of the total asset to equity ratio depends on the industry, present economic status, company’s sales and assets and various other factors. Though there is no ideal value for the ratio and it is used for comparing the business with its peers. However, high ratio indicates that the company is highly leveraged. Further, the reason behind the high asset equity ratio may be that the borrowed capital is more as compared to the capital cost (Akeem et al. 2014). Further. Very high ratio may lead the company to the unsustainable level as additional debt increases the cost of interest which in turn may deteriorate the financial status of the company. On the other hand, low asset-equity ratio indicates that firm’s position is strong and requires no further debt or the company is over conservative and missing the business opportunities.

• Reasons why ROE is greater than ROA

Structure of ownership governance

If the debt cost is lower as compared to ROA, then the company will earn on the debt and ROE will increase. Profit earned from debt as well as from additional equity will be more as compared to profit earned from equity only.  If it is assumed that the ROA is greater than the interest rate, it will state a loss on debt. Therefore, as it can be seen from the above table that the ROE of the company are more than ROA, it can be stated that it is earning on its debt.

1. Movements of monthly stock price for last 2 years

Movement of Oil Search Limited stock

1. Report on movement of the stock

It can be recognized from the above table and graphs that both the stocks are upward moving. However, if closely looked, it can be seen that the stock of Oil Search Limited is more fluctuating as compared to the All Ordinary Stock. Therefore, it can be stated that the stock of Oil Search Limited is more volatile. Further, the correlations between 2 funds are computed as 0.732. Therefore, the stocks are positively correlated.

• On 1^stNovember 2017, the company announced that it has acquired the interest in world-class Tier 1 oil assets under Alaskan North Slope with material potential of growth. The acquisition was 8 months of the comprehensive due diligence and it was very important comprehensive due diligence for the company.
• On 24^thAugust 2017 the company served notice regarding change in the substantial interest with regard to shareholding, under section 671B. For the purpose of notice the outstanding share balance of 15,23,631,192, shares were used for calculating the holding percentage.
• On 14^thJune 2017 the company successfully tested the production of Muruk 1ST3 to south west of Muruk 1 gas recovery. The drilling programme of Muruk successfully discovered the potential significant new gas field. The data generated from Muruk well and the 3 sidetracks will be analysed for assessing the potential resources for gas.
• On 3^rdJanuary 2017, the director of Oil Search Limited Mr Peter Botten changed his shareholding on account of the ordinary restricted shares. The consideration paid for each share was A$ 7.17. Prior to change, the number of shareholdings were 23,68,039 ordinary shares. After changing the holding, the number of securities held by the director was 15,94,082 ordinary shares.
• On 21^stNovember 2016 the company successfully help the TB patients to complete their treatment along with Kikori Hospital. The oil search foundation is continuing their support to the hospital with the ongoing food supplementation and is also working with the local group of women for providing food at lower cost for the patients.

1. Calculated beta for the company is 0.69
2. Risk free rate = R_f= 4%, market risk premium = R_m = 6%

Therefore, required rate of return for the company’s share =

R = R_f  + β ( R_m – R_f )

R = 4% + 0.69* (6% – 4%) = 5.38% (Zabarankin, Pavlikov and Uryasev 2014)

• Conservative investment

Conservative investment is the investment strategy that preserves the value of investment portfolio through investing at securities associated with lower risks. Lower risks here mean the investment with fixed money market securities and fixed income (Halili, Saleh and Zeitun 2015). The fund with lower beta, higher return and regular dividend paying may be considered as conservative investment. From the above analysis it can be found that the beta of the company is 0.69 which can be considered as low and the ROE of the company is more than its ROA (Renneboog and Szilagyi 2015). Further, it can be found from the annual report of the company that the company is regular in paying dividend to the shareholders and it paid 3.5 US cents dividend per share during the year 2016. Therefore, the company Oil Search Limited is considered as a conservative investment.

1. Calculation of WACC

For computation of WACC the company’s capital cost under each category of the capital is weighted proportionately. All the sources of capital that includes the preferred stock, common stock, bonds and other non-current debts are taken into consideration for calculation of WACC. With the increase of rate of return on the equity and beta the WACC of the company goes up (Ajanthan 2013). However, the increase in WACC denotes the reduction in valuation and increase in the risk. The WACC is calculates as follows –

Key ratios

WACC = E/V * R_e +D/V * R_d * (1-T_c), Where,

E/V = Percentage of equity in capital structure

D/V = Percentage of debt in capital structure

R_e = Cost of equity = 5.38%

R_d = Rate of debt = 4.85%

T_c = corporate tax rate

Therefore, WACC = 56*5.38% + 44*4.85% (1-0.515)

      = 3.018 + 1.03499

      = 3.16899% or 3.17%.

1. Implication of Higher WACC on management’s evaluation

The (WACC) weighted average cost of the capital is the rate which the company expects for paying on average to all the security holders for financing the assets. It is the company’s cost of capital (Zabarankin, Pavlikov and Uryasev 2014). Further, the WACC of the company is influenced by the external market and not by the management. It shows the cost of firm for using the money to the projects that are intended for generating growth. Whether the money is arranged through debt or through equity it comes in exchange of cost. Higher WACC denotes that the company is associated with more risk. Therefore, if the company has higher WACC, the management will try to arrange the fund through cheaper sources (Baños-Caballero, García-Teruel and Martínez-Solano 2014). In such cases, it is the indication that the company is losing its value and possibilities are there that more efficient projects are there for investing.

1. Optimal capital structure

The optimal capital structure is the optimum debt to equity ratio that can maximise the value of a company. For any company it is the one that provides the balance among the range of debt to equity and can minimizes the company’s capital cost (Albul, Jaffee and Tchistyi 2015). Theoretically, the debt finance is regarded as having low cost capital as compared to equity as the debts are tax deductible. However, with the increase of debt the risk of the company also increases. Generally, the debt ratio of 50% is considered as optimal capital structure as the company has a balance among its liabilities and assets (He and Krishnamurthy 2013). It can be seen from the above table that for both 2015 as well as 2016 the debt ratio of the company is more or less same and it is moving around 50%.

1. Gearing ratio

The gearing ratio measures proportion of the borrowed fund as compared to the equity of the company. If the gearing ratio of the company is high, it denotes that the company has high proportion of the debt to equity and the low gearing ratio represents the low proportion of debt to equity (Bodie, Kane and Marcus 2014). It can be seen from the annual report of the company for the year ended 31^st December 2016 that the long term borrowing of the company amounted to $ 37,58,906 thousand as compared to $ 40,12,278 thousand for previous year. Therefore, it can be stated that for adjusting the gearing ratio the company repaid their borrowings. However, the company did not issue any new shares and the share capital remained same at $ 31,47,340 thousand for both 2015 as well as 2016.

Information derived from the website of ASX

In light of the opportunities of high returning growth, the board of the company is in the view that the proportionate dividend policy ranging 30% to 50% of the core profits to the shareholders will be appropriate. Further, this return will be appropriate for providing long term as well as short term returns to the shareholders (Heikal, Khaddafi and Ummah 2014). Owing to this, the company paid the dividend of 3.5 US cents per share during the year 2016. Further, after the balance sheet date, directors approved for final unfranked dividend of 2.5 US cents per ordinary share for the year ended 31^st December 2016. Further, for final dividend, the dividend reinvestment plan of the company will be suspended.

From the above discussion, it is recommended that the client shall include Oil Search Limited in his investment portfolio. The reason behind this is that though the company’s return on assets as well as return on equity is lower in 2016, it is significantly higher as compared to the year of 2015. Therefore, it can be seen that the company is working on this and can be expected to give moiré return in future. Further, it is identified that the company is regular in paying dividend and therefore, it can be considered as a fund of regular income. Apart from this, it is found that for all the last 4 years the company maintained a stable debt ratio that states the balance among equity and debt is maintained. Moreover, lower beta and lower WACC represents that the company is associated with lower risk. To consider a fund for investment, generally the investor prefers for regular income and lower risk and Oil Search Limited fulfils both the criteria. Therefore, it shall be included in the client’s investment portfolio.

Reference 

Ajanthan, A., 2013. The relationship between dividend payout and firm profitability: A study of listed hotels and restaurant companies in Sri Lanka. International Journal of Scientific and Research Publications, 3(6), pp.1-6.

Akeem, L.B., Terer, E.K., Kiyanjui, M.W. and Kayode, A.M., 2014. Effects of capital structure on firm’s performance: Empirical study of manufacturing companies in Nigeria. Journal of Finance and Investment Analysis, 3(4), pp.39-57.

Albul, B., Jaffee, D.M. and Tchistyi, A., 2015. Contingent convertible bonds and capital structure decisions.

Baños-Caballero, S., García-Teruel, P.J. and Martínez-Solano, P., 2014. Working capital management, corporate performance, and financial constraints. Journal of Business Research, 67(3), pp.332-338.

Bodie, Z., Kane, A. and Marcus, A.J., 2014. Investments, 10e. McGraw-Hill Education.

Halili, E, Saleh, A and Zeitun, R., 2015. ‘Governance and Long-Term Operating Performance of Family and Non-Family Firms in Australia’, Studies in Economics and Finance, vol.32, no.4, pp.398-421.

He, Z. and Krishnamurthy, A., 2013. Intermediary asset pricing. The American Economic Review, 103(2), pp.732-770.

Heikal, M., Khaddafi, M. and Ummah, A., 2014. Influence analysis of return on assets (ROA), return on equity (ROE), net profit margin (NPM), debt to equity ratio (DER), and current ratio (CR), against corporate profit growth in automotive in Indonesia stock exchange. International Journal of Academic Research in Business and Social Sciences, 4(12), p.101.

Naser, K.A.M.A.L., Nuseibeh, R.A.N.A. and Al-Hadeya, A.H.M.E.D., 2013. Factors influencing Corporate working capital management: Evidence from an Emerging Economy. Journal of Contemporary Issues in Business Research, 2(1), pp.11-30.

Oilsearch., 2017. Home – Oilsearch. [online] Available at: https://oilsearch.com/ [Accessed 11 Jan. 2018].

Renneboog, L. and Szilagyi, P.G., 2015. How relevant is dividend policy under low shareholder protection?. Journal of International Financial Markets, Institutions and Money.

Zabarankin, M., Pavlikov, K. and Uryasev, S., 2014. Capital asset pricing model (CAPM) with drawdown measure. European Journal of Operational Research, 234(2), pp.508-517.

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