Comments on: PetroChina: A Look Back

By: azmath

azmath — Mon, 22 Feb 2010 09:50:01 +0000

Hi, I was exactly looking for this, and I found your article. But, can you say why buffet should choose 12x? Well, that must be the whole trick. But, to arrive at a particular multiple need a lost of wisdom. But its also equally strange, when he mentioned that company was worth $100 B when he bought it. How can he stick so exactly to the 12x multiple!

By: Berkshire Part 1: See’s and PetroChina | FutureBlind

Berkshire Part 1: See’s and PetroChina | FutureBlind — Fri, 07 Mar 2008 07:37:52 +0000

[...] in PetroChina. In October I wrote up a short case study on the investment in PTR, which you can see here. He confirms in writing that when they sold PTR back in September, he believed it was fairly [...]

By: Bill

Bill — Fri, 21 Dec 2007 00:36:41 +0000

I just finished Phil Town’s book “Rule #1″. –

Using his valuation method–in 2001 PTR’s EPS was $2, assuming the yearly growth rate of 24% for the next 10 years, the EPS will be around $17 in year 2011. Using the average P/E for petroleum companies–12, the “Sticker Price” of PTR will be 17*12=204 in year 2011. –

My desired return rate is 15% per year, $204 in year 2011 dicounted back to 2001 using 15% discount rate would be $51.Require a margin of safety 50%, I would buy PTR below 25 dollars. In 2002, the price for PTR was $16.–

This is neat.Thanks

By: Max

Max — Sat, 08 Dec 2007 06:48:30 +0000

“Is there a ratio to measure it?”
> Not necessarily. There are ways to measure growth expenditures for certain types of businesses but I can’t say for energy companies. I was referring to excess expenditures as (Total CapEx – Depreciation). It was fairly high in 2002 (they could have been building more refineries, or something similar), but leveled off to approximate depreciation in the years after.

No, I wouldn’t use the 12xEBIT number for energy companies in general. Again, they aren’t in my circle of competence, so I can’t tell you exactly how to value them. It really will depend on the specific company. Remember that PetroChina is the largest and most profitable energy company in Asia (which is growing much faster than the US). So it probably deserves a higher multiple than the average oil company.

By: Bill

Bill — Sat, 08 Dec 2007 02:00:36 +0000

Thanks again. I learned a lot.
How would you define “a lot of excess capital expenditures’? Is there a ratio to measure it?

In the future, when I value an energy company without excessive capital expenditure, can I just use 12*EBIT?

Thanks again.

By: Max

Max — Fri, 07 Dec 2007 23:36:01 +0000

Bill,

Yes, Buffett usually prefers Free Cash Flow, depending on the type of investment. PetroChina didn’t have a lot of excess capital expenditures, so in this case there won’t be much difference between net income and FCF.

In my above “valuation”, I was using 12x EBIT only because that’s the multiple that Buffett valued PTR at when he bought (he gave the $100B value). If I used Free Cash Flow instead, the multiple would be 25x FCF ($100B / $4B). I only used operating income because it is a more “normalized” number, and I didn’t have to take into account any growth capital expenditures. The EV/EBIT multiple also helped take away the effects of debt on the valuation.

By: Bill

Bill — Fri, 07 Dec 2007 19:28:48 +0000

Hi Max,
Thanks for your help on this.
My understanding is that Buffett prefers to use Free Cash Flow to value business, instead of operating income. Am I correct?

By: Max

Max — Fri, 07 Dec 2007 18:47:20 +0000

Bill,

Using the assumptions you laid out, your “10-year total” number looks correct. However, the value in perpetuity (the 11th year) must also be discounted back to the present.

In other words, the $6.52 annual cash flow is worth $72.4 in the 11th year. But that figure must be discounted back to 2002 (72.4/1.09^11) = $28.1 billion.

So, the final value, using your figures, would be: $31.2 $28.1 = $59.3 billion. With 1.76B shares outstanding at the time, this would be about $34 per share. Not as much as my value above (at 12x operating income), but still double the price it was trading for at the time.

By: Bill

Bill — Fri, 07 Dec 2007 02:28:10 +0000

I try to back engineering Buffett’s valuation of PetroChina back in 2002. In 2001, PetroChina had free cash flow of $4billion, assuming 5% growth in cash flow for the next 10 years, and no growth starting the 11th year, discount rate 9%, the DCF valuation of PetroChina looks like this:

Year—- Free Cash Flow—- Discounted Value (Billion)
2002—- 4.00—- 3.67 (4/1.09)
2003—- 4.20—- 3.54 (4/(1.09^2))
2004—- 4.41—- 3.41
2005—- 4.63—- 3.28
2006—- 4.86—- 3.16
2007—- 5.11—- 3.04
2008—- 5.36—- 2.93
2009—- 5.63—- 2.82
2010—- 5.91—- 2.72
2011—- 6.21—- 2.62
10-year total—-$31.19 billion

Year—-Free Cash Flow—- Discounted Value (Billion)
Later—-6.52—- 72.40 billion (6.52/0.09=72.40)

$31.19B plus $72.40 =$ 103.59 billion.

I’m a newbie learning the valuation right now. Please let me know if my valuation is correct