Chapter II – CASE STUDY at OMV PETROM S.A.

2.1. Company presentation and valuation background:

OMV Petrom is a Romanian oil company, the largest corporation in Romania, which,
according to “Ziarul Financiar” has a 2013 market value around RON 5,708 mn. Also, Petrom
represents the largest gas and oil producer in Eastern Europe with activities in the business
segments of Exploration and Production, Refining and Petrochemicals, Marketing, Gas and
Energy.

Regarding to the valuation process, this case study is assessing Petrom’s business
using the following three valuation methods:

2.2.1. Company valuation using INCOME/EARNINGS –based method:

Stock variation and EPS

2011 2012 2013

EPS
(RON/share) 0.0663 0.0698 0.0851
Year's low
(RON) 0.2750 0.2900 0.4098
Year's high
(RON) 0.4500 0.4327 0.4784
Year's end
(RON) 0.2900 0.4281 0.4698

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑠𝑡𝑜𝑐𝑘 𝑌𝑒𝑎𝑟 ′ 𝑠 ℎ𝑖𝑔ℎ+𝑌𝑒𝑎𝑟 ′ 𝑠 𝑙𝑜𝑤 0.4784+0.4098

= = =0.4441 RON/stock
𝑝𝑟𝑖𝑐𝑒 2013
2 2

Price/Earnings Ratio method

𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒔𝒕𝒐𝒄𝒌 𝒑𝒓𝒊𝒄𝒆 𝟎.𝟒𝟒𝟒𝟏

𝑷𝒓𝒊𝒄𝒆/𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 2013 = = = 5.22 RON/stock
𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆 𝟎.𝟎𝟖𝟓𝟏

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Result interpretation:

If Petrom’s stocks are trading at 0.4441 RON/stock and the earnings per share for
most recent 12-month period is 0.0851 RON, then Petrom’s stock has a P-E ratio of 5 (adjusted);
with other words, the purchaser of the stock is paying 5 RON for every RON of earnings.

Earnings per share is the basic measure of a company’s performance from an ordinary
shareholder’s point of view. It is the amount of profit , in cents, attributable to each ordinary
share.

If this P-E ratio is compared to the P-E ratio of the industry the company is in:

Petrom OMV current P-E ratio Oil/Gas Industry (Integrated) P-E ratio
5.22 > (1*) 10.97

, results that either the stock is undervalued, or the company’s earnings are thought to be in
decline.

Investors are willing to buy shares in the company at 5.22 times last year’s earnings
compared with the previous year’s position when they were willing to pay 5.18 times the
earnings. This increase may be because the company is expected to grow as much as in the
previous year. The industry average PE increased year-on-year from 10.21 to 10.97, which may
suggest that this company is expected to generate greater growth or carries more risk than the
industry average.

Alternatively, current earnings may be substantially above Petrom’s historic trends

or the company may have profited from selling assets.

(1*) S&P Capital IQ, Bloomberg and the Fed;

Date of analysis : January 2014;
2.3. Company valuation using INCOME-based method:

“In terms of tools and techniques, Petrom follows the best international practices in
risk management and uses stochastic quantitative models to measure the potential loss associated
with the company’s risk portofolio under a 95% confidence level and a three-year horizon.
All risks are analysed based on their causes, consequences, historical trends, volatilities and cash
flow potential impact.” (2*)
(2*) (Petrom’s 2013 Integrated risk management system report).

Business risk free rate(3*) = 1− Confidence level associated with company’s risk portofolio

2
 = 1− 0.95 = 0.05 = 5% ;
(3*) “What is the free-risk rate? A Search for the basic Building Block”, Aswath Damodaran,
Stern School of Business, New York University, December 2008).
The discount rate captures the business risk and represents the required rate of
return to make a business worthile, as an investment decision.
[Discount Rate > Business Risk Rate] ↔[11% > 5%]
assuming a 11% real return rate for fund providers in order to compensate inflation;

Romanian inflation rate evolution -2010-2013- (4*)

2010(%) 2011(%) 2012(%) 2013(%)

Inflation rate 6.09 5.79 3.33 3.98

Average inflation 4.79

(4*) (National Institute of Statistics and Economic Studies).

The real rate and money rate returns are linked by the formula (5*):
r = money rate;
1+𝑖
1+ r = ; where : h = inflation ;
1+ℎ
i = real rate;
1+i 1+𝑖
1+ 11%= ↔1.11= ↔ 1+ i=1.11×1.0479 ↔ i=0.1631↔i=16.31%
1+0.479 1.0479

(5*)ACCA -F9, Financial Management ,ch.4 –“Investment appraisal-further aspects of DCF”)

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Discounted Cash Flow method:

The impact of inflation over Petrom’s real cash flows (2010-2013)

TIMING REAL/CASH INFLATION MONEY DISCOUNT PRESENT
FLOW FACTOR CASH FLOW FACTOR VALUE
(a) mn. RON (b) (a)x(b) mn. RON @ 16.31% mn. RON

2010 4,630 1 4,630 1.000 4,630

2011 6,442 1+0,0479 6,750 0.859 (6)* 5,790
2012 7,185 (1+0,0479)2 7,890 0.739 5,830
2013 8,048 (1+0,0479)3 9,260 0.635 5.880
NET PRESENT VALUE 22,130

(6*) Present value of 1=(1+r)-n , where: r = discount rate;

n = number of periods until payment.

1/1.1631 = 0.859;

1/1.16312 = 1/1.3528 = 0.739;

1/1.16313 = 1/1.5734 = 0.635;

Result interpretation:

For Petrom, this income approach valuation tool determines the value of the business
based on its ability to generate desired economic benefits for the owners;

Furthermore, for achieving this 4-years-NPV result, mn. RON 22,130 ,the largest
contribution was provided by the 2013-real-cash-flows , which represents 36.36 % of the NPV,
including the influence of the last 4 years inflation.

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 Cash Flow evolution related to the investment
policy in the last 4 years

9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
2010 2011 2012 2013
C.F. from operating
4,630 6,442 7,185 8,048
activities
investments 4,863 4,803 4,930 5,303

In other words, this positive NPV is an indication of the surplus funds available to the
investor now as a result of continuing the investment policy.

Overall, this valuation tool shows a desirable NPV, which can be understood as a
positive outcome if the investment appraisal is related to the outflows that Petrom is generating;
and , excepting the 2010 financial year, for the last years the cash flow from operating activities
exceeded the company’s investments – which reflects the importance of establishing the
investment policy by taking into account the business stream of future economic benefits
discounted to their present value.

2.4. Company valuation using ASSET-based method

The 3-rd valuation method is a mixed tool which involves the determination of fair
value of all assets and liabilities adjusted with the current value of the working capital business
in order to assess the importance of the covering the short-term obligations.

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 Petrom’s Working Capital adjusted (+/-) with asset accumulation policy:

mn. RON

(+) CURRENT ASSETS 5,487

(-) CURRENT LIABILITIES (5,167)
(=) WORKING CAPITAL (3) 320
(-) PENDING LEGAL JUDGEMENTS- a fine imposed by the Romanian
Competition Council as a result of the antitrust investigation (503)
(+) KEY DISTRIBUTION AND CUSTOMER CONTRACTS- a farm-out
agreement with REPSOL (Argentina) 225
(-) PROPERTY AND INCOME TAX OBLIGATIONS –
Deferred Income (107)
Provisions for taxes to be paid to Romanian state (235)
Provisions for late payment interests (2009, 2010) (209)
(+) STRATEGIC PARTNERSHIP AGREEMENTS- Jointly controlled 504
assets
(-) ENVIRONMENTAL COMPLIANCE COSTS – Environmental (232)
provision
(=) ADJUSTED NET ASSETS ACCUMULATION FOR 2013 Y/E (9) (557)
(3)+(9) PETROM’s WORKING CAPITAL ADJUSTED(+/-) WITH NET
ASSETS ACCUMULATED (237)

Result interpretation:

The third valuation tool reflects the influence of off-balance sheet assets and
liabilities over the Petrom’s working capital in 2013 financial year.

Positive Working Capital, (mn. 320 RON), means the fact that the business
currently is able to pay-off its short-term liabilities with its current assets; Petrom’s currently
6.19 % financial excess of the operating liquidity available to business can be a signal that the
company might be able to expand its operations in the near future.

Total investments for Petrom in 201 are represented by mn. 5,303 RON even
the actual debt that the investor owes (mn. 237 RON) will be offsetted by the positive effect of
the assets accumulation policy which can be cash assets or real property.
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 A review over the customer contract made by a farm-out agreement between
Petrom and Repsol (a global integrated energy company) reveals the best example of real
property asset accumulation which is represented by a € 50 mn. investment in the next two years.

Overall, the asset accumulation valuation method, at a current debt rate of

4.47 % from total current investments activities represents Petrom’s long-term vision of
increasing portfolio values, net worth and savings account balances, as cash is saved or invested
and then grows through interest earnings and investment gains.