AFM 373 Lecture 1: Midland

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Accounting & Financial Management
AFM 373
Alan Douglas

Operations – incorporated more than 120 years ago and in 2007 had 80,000 employees Exploration & Production - 2.10 million barrels of oil per day – 6.4% increase from 2005 - 7.28 billion cubic feet of natural gas/day - less than 1% increase - most profitable business, net margin for past 5 years highest in industry - expect heavy investment in acquisitions of properties, reserves to expand production Refining and marketing - 40 refineries around the world, 5million barrels/day - largest revenue producing segment - products highly commoditized so competitive - projected WACC would remain stable or longer -term global shortage of refining capacity that would spur investment Petrochemicals - smallest division, substantial business though - equity interests in 25 manufacturing facilities and five research centers in 8 countries around the world - revenue was 23.2 billion in 2006 and 2.1 billion in earnings in 2006 - capital spending expected to grow as older facilities sold/retired and replaced by newer, more efficient ones - investment would be by joint ventures outside of US (they have substantial minority interest) Financial Investment Policies - 2007 financial strategy based on 4 objectives: find overseas growth, invest in value -creating projects in all divisions, o ptimize capital structure, opportunistically repurchase undervalued shares Overseas Growth - easily exploited domestic resources are being put into production - main growth for most large U.S producers - specialized financial and contractual agreements - lead developer for the project (Midland collect management fee/royalty - foreign partner got 50% plus preferred return) - converted foreign currency cash flows to dollars and applied U.S dollar discount rates - earnings from equity in 2006 of 4.75 billion (77. 7% come from non-us investments) Value Creating Investments - discounted cash flows to evaluate prospective investments - debt-free cash flows and hurdle rate equal to WACC for the project/division - overseas projects: future equity cash flows discounted at co st of equity - performance of a business/division measured in two ways o Performance against a plan over 1,3,5 year periods o Economic value added (debt -free cash flows reduced by capital charge and expressed in dollars), capital charge = WACC for the business OR division *amount of capital employed in the period Optimal Capital Structure - Borrow in its energy reserves and in long -lived productive assets - Debt levels reevaluated and long -term targets set accordingly - Changes in energy price levels correlate with c hanges in their stock price so need to reassess often o If high, increase in borrowing capacity, opportunity to shield additional profits from taxes - Each division has its own target debt ratio based on divisions annual operating cash flow and collateral value of its identifiable assets o Changes in market value of specific collateral (oil reserves/market capitalization) could drive actual debt ratios away from corresponding targets - Estimate debt rating for each division based on its target - Company’s debt rated A+ by standard and poor - Yield to maturity for U.S bonds January 2007 - Strength of consolidated balance sheet and access to global financial and commodity markets - Desire to manage risks, take advantage of private info or unusual pricing relationships mea ns that capital structure sometimes departed from planned targets Stock Repurchases - Regularly estimated intrinsic value of shares by= (fundamental value of enterprise- market value of debt)/ # of shrs outstanding - Fundamental value estimated using DCF - When stock price fell below stock’s intrinsic value, they consider repo - Estimating cost of capital Cost of debt - Calculated for each division by adding a premium over US securities of a similar maturity o Depends on cash flow from operations (long-term expected cash flow and collateral affected by political risk) o Risk of nationalization or forced renegotiation of production rights high because assets/reserves in risky countries Cost of Equity - CAPM model - She and her term used betas published commercially instead of running their own regressions - Betas for divisions not observable , looks at publicly traded companies comparable to the division - Beta for firm is 1.25 - 2006 equity market risk premium was 5% (consult professional advisors) 1. Role: Who are we? [in this case] Janet Mortensen, senior VP of project finance for Midland Energy Resources 2. Issue: Why are we here? She’s preparing cost of capital est
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