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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.

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