Financial analysis of energyfirms

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Copyright © 1998 Thunderbird, The American Graduate School of International Management. All rights reserved. This case was prepared by Professor Graeme Rankine for the purpose of classroom discussion only, and not to indicate either effective or ineffective management. The data used in this case was obtained from, and used with permission of, Compustat PC Plus, an analytic software system integrating financial statement and market information produced by Standard & Poor’s Compustat, Englewood, Colorado.

Financial Analysis of Energy Firms

Amerada Hess Corporation, Mobil Corporation, Pennzoil Company, and Unocal Corpo- ration are four energy companies headquartered in the United States. The four firms have some characteristics in common. Amerada Hess, Mobil and Pennzoil are classified as being involved in petroleum refining [Standard Industrial Classification, SIC 2911] while Unocal is classified as involved in crude petroleum and natural gas [SIC 1311]. The firms are all involved in the exploration and production phase of the energy business. The firms differ in their involvement in downstream activities. For example, Mobil has been a major player in the retail marketing of gasoline both in Europe and in North America while Amerada Hess has been a significant retail marketer on the East Coast. Unocal shifted its focus from refining and marketing to exploration and production. Pennzoil has had only a modest retail gasoline marketing position. The firms also differ in terms of size. For example, rev- enues in 1997 ranged from $64.3 billion for Mobil to $2.5 billion for Pennzoil.

Company Backgrounds

Amerada Hess Corporation (NYSE: AHC), incorporated in 1920 as Amerada Corp., re- sulted from the merger with Hess Oil & Chemical Corp. in 1969. In 1989, the company acquired oil and gas properties from TXP Operating Company, a Texas limited partnership affiliated with Transco Energy Company, for $865.6 million. In 1990, the company formed a joint venture with the government of the West African Republic of Gabon to develop the Rabi-Kounga oil field at a cost of $300 million. At the end of 1997, the company was a major integrated oil company with 595 million barrels of proved crude oil and natural gas liquid reserves and 1.935 trillion cubic ft. of proved natural gas reserves.

The company’s exploration and production activities were located primarily in the United States, United Kingdom, Gabon, and Norway. The company also conducted explo- ration and/or production activities in Denmark, Indonesia, Thailand and other parts of the world. Of the company’s proved reserves, 34% were located in the United States and 60% were located in the United Kingdom, and the Norwegian and Danish sectors of the North Sea. In 1997, the company refined more than 411,000 barrels a day and sold gasoline in over 638 HESS stations, mainly in New York, New Jersey and Florida. The company’s St. Croix, Virgin Islands refinery was one of the world’s largest. In early 1998, Amerada an-

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nounced a joint venture with Petroleos de Venezuela, S.A. (PDVSA) to operate the St Croix refinery. Under the terms of the agreement, PDVSA acquired a 50% interest in the refinery for $625 million. Amerada Hess’s web page on the Internet was located at www.hess.com.

Mobil Corporation (NYSE: MOB) was incorporated in New York in 1882 as Stan- dard Oil Company of New York. The company’s name was changed to Socony-Vacuum Corporation in 1931, to Socony Mobil Oil Company, Inc. in 1955 and to Mobil Oil Corporation in 1966. In 1988, the company sold Montgomery Ward & Company for $1.6 billion in cash to an investor group which included its senior management, General Elec- tric Capital Corp. and Kidder, Peabody and Company. In 1996, an Australian subsidiary, Mobil Exploration and Producing Australia Pty Ltd, acquired Amplolex Limited, an Aus- tralian oil and gas company, for approximately $1.4 billion. In 1996, the company also acquired a 25% interest in the Tengiz oil field in the Republic of Kazakstan, a state of the former Soviet Union, for $1.1 billion under terms that required an initial payment of $500 million. In 1996, Mobil announced that it and British Petroleum would pool assets with a book value of $5 billion to create a partnership across Europe with annual sales of $20 billion.

In 1997, Mobil was one of the largest oil and petroleum companies in the world. The company owned 23 ocean-going tankers, operated an additional 12 tankers under term charter arrangements, and owned 15,000 retail outlets, of which 48% were located in the United States. At the end of 1997, Mobil had reported proved reserves of 4.1 billion barrels of oil and natural gas liquids and 17.0 trillion cu. ft. of natural gas. Mobil also operated a fully integrated chemicals operation which produced and marketed basic petrochemicals, selected specialty chemicals, catalysts and flexible packaging films. In 1997, Mobil’s Chair- man reported that the new five-year goal for the company was to generate returns to share- holders that were in the highest quartile of comparable energy companies. In order to reach that objective, the company set new targets, using 1996 as the base year: a 10% per year increase in operating earnings to $5 billion by the year 2001; a 14% average return on capital employed over the period; and, a $100 stock price by 2001. To support these targets, Mobil established goals for its operating units, including: increasing oil and gas production by an average of at least 4% a year, replacing more than 110% of the reserves produced over the five-year period, growing trade sales volumes in fuels and lubricants by an average of 4% to 5% a year, and increasing chemical sales volumes by 7% a year. Mobil maintained a web page (www.mobil.com) on the Internet.

Pennzoil Company (NYSE: PZL) was formed in 1968 through the combination of Pennzoil Co., which was established in 1889, and United Gas Corp., which was organized in 1930. In 1990, Pennzoil acquired an 80% interest in Jiffy Lube International, which became a wholly-owned subsidiary in 1991. The company explores for oil and gas, refines and sells Pennzoil motor oil, and provides oil-change services at 1,500 Jiffy Lube outlets located throughout the United States. Pennzoil brand gasoline is marketed through 403 retail outlets located in Pennsylvania, Ohio, New York, Virginia, Tennessee and Kentucky. In 1985, the company distributed the stock of Battle Mountain Gold Company to its shareholders in a spinoff on a one-for-one basis. In 1985, the company was awarded $10.5 billion in damages after being scooped by Texaco in the acquisition of Getty Oil. After

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Texaco entered bankruptcy protection in 1987, Pennzoil settled the dispute for $3 billion which it received in 1988 after Texaco’s plan of reorganization was approved by the bank- ruptcy court.

In November 1997, Union Pacific Resources Group Inc. dropped its $6.4 billion hos- tile bid for Pennzoil. Pennzoil had previously rejected the all-cash offer of $84 per share as inadequate. At the end of 1997, Pennzoil’s Chairman reported that the company was on track to achieve its financial goals for the end of the decade of doubling operating income and after-tax cash flow from operations from the 1994 levels, and reducing the adjusted debt-to-cash flow multiples to around two times. At the end of 1997, the company had proved oil reserves of 227 million barrels and proved natural gas reserves of 1.059 trillion cubic ft. Pennzoil’s web page (www.pennzoil.com) was located on the Internet.

Unocal Corporation (NYSE: UCL) was originally incorporated in Califormia in 1890 as the Union Oil Company of California. In 1983, the Union Oil Company reincorpo- rated in Delaware as a wholly-owned subsidiary of the company. In 1996, the company sold its California crude oil and natural gas assets to Nuevo Energy Company of Houston, Texas for $492 million. In 1997, Unocal was a leading global resource and project develop- ment company, with major oil and gas exploration and production activities in Asia, Latin America and the United States Gulf of Mexico. Unocal was also the world’s leading pro- ducer of geothermal energy; a provider of electrical power; and a manufacturer and mar- keter of nitrogen-based fertilizers, petroleum coke, graphites and specialty minerals. In March 1997, Unocal further transitioned itself from a fully integrated oil company by completing the sale of its West Coast refining, marketing and transportation assets to Stamford, Conn.- based Tosco Corporation. Unocal received cash proceeds of $1.4 billion and 14,092,482 shares of Tosco common stock valued at $397 million. In May 1997, the company sold the stock back to Tosco for $394 million (net of expenses).

The company has continued to shift its focus toward growth through higher-return resource drilling and market-to-resource project development. To help accomplish this growth strategy, the company acquired a number of new exploration blocks in prospective areas in Argentina and in deepwater areas in the Gulf of Mexico and offshore Indonesia. Advanced technology was expected to provide deepwater exploration and production opportunities to the company that were previously uneconomic. In 1997, the company participated in its first deepwater discovery in the Gulf of Mexico and made several discoveries confirming significant resources in the East Kalimantan area, offshore Indonesia. The company planned to grow through greater exploration success, increased international production, effective cost controls and active portfolio management. To help achieve these goals, Unocal ex- pected to focus its 1998 capital spending on the Lower 48 United States, international operations and new ventures activities. At the end of 1997, the company had proved re- serves of 533 million barrels of oil and 6.550 trillion cu. ft. of gas. Unocal’s web page on the Internet was located at www.unocal.com.

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EXHIBIT 1 Some Definitions of Key Ratios

LIQUIDITY RATIOS: Cash & Market Sec. to Total Assets = (Cash + Marketable Sec.) / Total Assets Acid Test Ratio = (Cash + Marketable Sec. + Receivables) / Current Liabilities Current Ratio = Current Assets / Current Liabilities

ASSET MANAGEMENT: Day’s Receivable = 365 / (Sales / Receivables) Day’s Inventory = 365 / (Cost of Goods Sold / Inventories) Asset Turnover = Sales / Total Assets

FINANCIAL LEVERAGE: Debt to Total Assets = (CL + L-T Debt + Other Liabilities) / Total Assets Stockholders’ Equity to Total assets = Total Stockholders’ Equity / Total Assets Long-term Debt to Stockholder’s Equity = (L-T Debt + Other Liabilities) / Stockholders’ Equity Coverage Ratio (1) = Operating Profit / Interest Expense Coverage Ratio (2) = (Operating CF + Interest Paid) / Interest Paid

PROFITABILITY: Gross Margin Ratio = Gross Profit / Sales Return on Sales = Net Income / Sales

(Adj. Net Income + Preferred Divs.) / Sales Return on Assets (1) = Net Income / Total Assets

(Adj. Net Income + Preferred Divs.) / Total Assets Return on Assets (2) = (Pretax Income + Interest Expense)/ Total Assets Return on Equity = Net Income / Stock. Equity

(Adj. Net Income + Preferred Divs.) /Stock. Equity Return on Common Equity = Adj. Net Income / Common Stock. Equity

STOCK MARKET PERFORMANCE: Dividend Yield = Cash Dividends / Market Price per Share (12/31) Annual Common Stock Return = (Price

t + Divs

t - Price

t-1 ) / Price

t-1 Market-to-Book Ratio = Market Price per Share / (Common Stockholders’

Equity /Common Shares Outstanding) DUPONT ANALYSIS:

Return on Equity = Return on Sales * Asset Turnover * Leverage = (Net Income / Sales ) * (Sales / Assets) * (Assets /

Stock. Equity)

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