This is undervalued- My Perspective
Published on September 27, 2007
Published on September 27, 2007
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As you might have noticed in my past few posting that I have been covering this “underlying” for a while. Today I am going to share my thoughts on this purely from “Fundamental Analysis” perspective. Note though, there are several ways to value a stocks and it very much depends on accuracy and assumptions of “variables”. I am presenting on what I think is a right set of assumptions, but feel free to run your analysis. This is just a start !
Grant Prideco, Inc. is engaged in drill stem technology development, drill pipe manufacturing, sales and service, and drill bit technology and specialty tools, manufacturing, sales and service. It is also a provider of performance engineered connections and premium tubular products and services. Its drill stem and drill bit products are used to drill oil and gas wells, while the tubular technology and services are primarily used in drilling and completing oil and gas wells. The Company’s customers include oil and gas drilling contractors, North American oil country tubular goods (OCTG) distributors, independent and state-owned oil and gas companies, and other oilfield service companies. It operates through three business segments: Drilling Products and Services, ReedHycalog and Tubular Technology and Services.
Over US$2.0billon business is split as per follows:
From the attached graph it is quite clear that GRP seems undisputed leader when it comes to drilling product markets. Nearest competitor is Valurac and even that doesn’t come close to GRP. No doubt consolidations may happen and a large competitor may emerge but that is still a long way to go.
Next I look at comparison with the nearest competitor, my two concerns will be Margin, and an efficient velocity. From a margin perspective, undoubtedly GRP is placed in a leading position.
SLB and HAL seems nearest. Let me pull more data for a comparison with them (using moneycentral.com). SLB is surely a much stronger company, but if I were to choose from Value standpoint, to me it’s GRP, sweetner is little debt. Margin are surely superior as well. You may want to check out further comparisons, with other companies using msn’s research wizard facility. It’s free. To know about the business, you may want to check out GRP’s website. They have assembled a good deal of presentation that can tell you more about the business, segments and it’s competitiveness (click here).
The only portion I am not reviewing is “Management”, that you may wanna checkout by searching their names and their past history.
Let’s dive into two methods of valuations.
First I’ll use discounted cash flow method, adopted from “Warren Buffet Way”. This is a “Two Stage Growth Model” where I have assumed 15% growth for 1st 5yrs and 8% in the next 5 years and so on. 15% is very conservative estimates when compared with >20% estimate consensus by 11 analysts. 2nd stage growth I have assumed is only 8% which is also quite conservative and something what huge companies organically grow by.
My calculation showed $414.8 as owner’s earnings (I have mentioned formulae in the screenshot). Another key variable is the discount rate. I have two choice a) either use Risk Free Rate (US 30year bonds)+ Equity risk premium, that’s roughly 11% or b) Use Weighted Average cost of capital (WACC) which according to S&P is also about 11%. To be little more conservative I am adding one more % and using 12% discount rate.
To calculate terminal value from year 11, I have used “capitalization rate” which is = discount rate-2nd stage growth rate and it is 4%. Using NPV methodology, I arrive at $71.97intrinsic value. You may model is with your own assumptions. If I just change my growth assumptions to 20% (as analysts predict for next 5 yrs) and replace discount rate by WACC (11%), the intrinsic value is close to $117.85. Based on $71.97, I can now purchase the shares at about 25% discount to its intrinsic value.
I’ll use one more method to evaluate whether or not it’s undervalued. This method was brought to my attention by one of the OP readers (Thx Dayton). It is called Rule#1 by Phil Town. Based on fundamental analysis, here are the highlights:
When I plug all those numbers and assume the same growth as I did in DCF Model 15%, I arrive at $51.45 price. This is the price that is with 50% Margin of safety to deliver 15% per annum returns. In fact $102 is the value that I arrive using that methodology.
There are several other methods i.e. comparable but I think those are relatively shaky. But even if I use those methods, it’s quite clear that GRP is undervalued and a great buy in my opion, it has potential to deliver 15% per annum nicely except if the business deteriorates.
There are watchouts though, higher than expected customer inventory of drill products, lower off-shorre and drilling activity, lower oil and natural gas prices, higher cost, delays in intelliserve tech deployment and of course Management (I dind’t much research to find out about them yet). If any of these signs surfaces, time to re-run the model.
Value investing is very different from options trading, and one must understand the business, the management team, industry prospects so as to hold on it during tough times.
Profitable trading, OP