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Pacrim Energy Limited: Company Analysis

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Pacrim Energy Limited: Company Analysis

Pacrim Energy Limited

Pacrim energy ltd is a company listed in Australian stock exchange which its nature business is exploration of oil. In order for one to understand Pacrim Energy Limited, one will need to understand the activities of the company. The principle activity of this company is exploration of oil and gas. Currently the company has many projects which are dealing with gold, which is exploration away from, the original objectives of the company. The company has gold fields in various parts of Australia such as golden terrace north Redcliff. Goldfield Australian Pty limited, sulphide project, grants Greek and Anglo project. These projects are new projects that the company has undertaken from the energy go exploration of gold. This diversification has assisted the company in its growth. The company is also has projects in the USA and some parts of Africa. They have an aim of entering some parts of South America, in exploration of gold. According to the financial statements of the company the year 2006, the exploration of gold, was becoming a good investment attraction for the company. The company is also exploring some projects away from Australia into places like California.

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The future prospects of the company as reported in the financial statements of the company suggest that the company is on the growth path of increasing its exploration area. Its is uncommon for a company that started as a Energy company to enter into mining gold. The chairman of the company has indicated in this statement for annual report of the year 2006 that the growth of the company was prospective and the company was intending to two further. The statement by the chief executive analyses and gives a portfolio of projects that will be undertaken by the company.

This report undertakes to analyze the financial performance considering the past and the future growth of the company. The report will cover two years 2005 and 2006. In these two years the company made losses as indicated below:

Year 2005 2006
Net loss 951,480 6,617,151

From the financial statements of the company, the company performance is deteriorating for the past two years because the net loss is increasing. This shows that the profitability of the company is going down as compared to industry players.

Looking at the balance sheet of the company which shows the situation of the company in long term survival that is the ratio of assets, liabilities and owner equity, we find that the current assets were reducing as well as the non-current assets the company’s total assets reducing from 14,848,592 to 8,261,580 million for the parent company. For the consolidated financial statement it also reduced from 11,893,003 to 8,259,834. At the same time total liabilities reduced from 117,255 to 100,523. The net loss that has been accumulating also has a devastating effect on the owners’ equity because the owner’s equity also reduced from 11,775,748 to 8,159,311. This shows a free fall for all the assets of the company, liabilities and equity. The loss that is increasing for the period is reflected in the company’s share price since the investor’s loose confidence in the company and they start selling their shares. The share price of the company from the company’s website shows that it was selling at 0.01 Australian dollars in the market. This was the worst result since its listing in 1989. Although it it’s an improvement from the trading in 31st December 2008.

Looking at the cash flow statement of the company it will not escape the mind of an investor that the company’s cash flow is also reducing because during the year 2005, the cash flows were 3,995,751 which was due to a net increase in cash inflows. However in the year 2006, the reported cash flow is 1,337,559 which were due to a net cash decrease for a period. Looking at the activities that caused this net decrease for the loss that made by the company can be used for exploration activities. The cash flow statement of a company usually shows the ability of the firm to finance day to day operations without borrowing. The cash flow shows investing operating and financing activities of the organization. In summary, the activities of this company can be summarized as shown below.

Year 2005 2006
Cash flow from operating activities -3,874,783 – 518,610
Cash flow from investing activities -1,037,007 -2,078,861
Cash flow from financing activities -7,832,970 0
Net change is 2,921,180 -2597451

From the statement above it shows that the company profitability deteriorated earlier before the year 2006, because the increase in cash flows in the year 2005, is majorly attributed to the financing activities of the company by issue of new shares at the cost 8,100,287. This was a downfall of the resources of the company.

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The discount rate that will be used

The discount rate that should be used in valuing the shares of this company should be discount that is arrived by the use of many methods depending on the investors’ long term and short term goals. Some investors will use weighted average capital (WACC) of the company which will consists of convent able notes and shareholders equity or the cost by other acceptable methods. However, most investors have limits of risks therefore they will choose a different method that considers risks. For those investors who are not huge risks takers, they use the model called Dividend Growth Model, to value shares of company. However, in this case the company will not be valued using this method because they have not issued dividends for the last 2 years. It has been said that this model has been proven strong, low risk and can produce long term returns comparing to the other model that investors used. To use this model, investors must be patient watching while their dividends were slowly increasing annually. The concept behind this model of investing is to buy a solid share with tracks of increasing dividend annually.

In this case we shall use capital asset pricing model which considers higher rate of risks than dividend growth model. Capital Asset Model is a model for pricing an individual’s security or a portfolio. The investor has a higher rate of risk since he invests in the form of assets. An asset or portfolio may be in the form of bonds, stocks, options, warrants, real estates and all its other forms. In this kind of model, investors who are risk averse will be comfortable in valuing the intended purchase or they are holding. Given two asset with the same expected return, it is expected that they rather choose the less risky. Investors can lower their risks by holding non-diversifiable risk portfolio. Diversification allows the same portfolio return with reduced risks.

The model assumes that an expected return, investors would likely prefer lower risk than higher risks. Given a certain level of risk they will prefer higher returns to lower ones. Investors do not accept lower returns for higher risk. The model assumes that all investors agree about the risk and possible returns of all assets. The model also assumes that there is no tax or transaction costs.

The modern portfolio theory uses diversification to optimize their portfolios and how a risky asset should be priced. Its basic concepts are the use of Markowitz diversification, the efficient frontier, capital asset pricing model, the alpha and beta coefficients, the capital market line and the securities market line. The two model is related since the two uses diversification, it allows them to limit their risk in investing through this process.

For the investor to know the risk of a share, he must have it beta which measures the volatility of the shares of a company. The beta of the company chosen has not been provided and this makes it difficulty to measure volatility of shares. Beta measures the sensitivity of the stocks price to market forces in the market. It is more sensitive to the changes in the market since the beta is more than one. It is always assumed that the overall market beta is equal to one. Therefore the inclusion of this company in the portfolio will increase the risk of the company at the same time increase the profitability since a higher risk has a higher return. A decreasing market returns generates a decreasing security returns. If the market experiences 10% decrease the Samson oil and gas limited securities will experience 12 % in its returns. This means that if it is a positive return then they will have higher profits, in consideration of these facts the inclusion of these in the overall portfolio will increase the risk consequently increase the profit near future.

The beta for this company is 0.27 and the risk free rate which has been considered in analyzing the share price of this company is 8%. This is available from finance yahoo of the 2nd January 2009. From the market rate of 12% for S & p 500 the market rate for the company will be 9.08 %. It means that the investors cannot buy the shares at a rate which is higher than 9.08% considering a market free rate of 12%.

The Linkage between Earnings per Share and the Share Increase of the Company

The decline in profitability of a company is also reflected in the share prices of the company. This is because potential and exiting investors are only interested in a company that will be able to increase their investments and expand their income. Always the shares of the company are valued using earnings per share through the earnings per share and the price earnings ratio and if the company makes a loss, the earnings per share will be a loss per share and their will be no price earnings. This means that the shareholders will move away from the shares of the company because of the negative price earnings ratio. No investor will be interested in a security that does not generate income. Considering the current example, the company performance is as follows:

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Year 2005 2006
Net loss 4,224,639 3,251,142
Diluted earnings per share (0.71) (0.44)
Price earning

The decline in profitability may be due to worsening of the world economy but the price is also going down. This decline in result means that the shareholders lost confidence in the share of the company and decided to sell their shares. This is why the market estimated the shares of the company at a certain price, although the price is not a true reflective of the earnings of the company. The market price of a company is always a multiple of earnings. If the earnings are negative then we expect a fall in the price.

The effect of different growth rates on the share price

According to White GI, et al (1997) different dividend growth rates will complicate in analysis of the company’s uniform growth rate meaning that the growth rate of the company in terms of the assets and earnings will depend on the performance of a particular year. And in order to understand the relationship between growth rates of different aspects in the balance sheet, the rate of return on assets should be analyzed. There is a constant growth rate for some companies others do not have any growth rate while others don not have non-uniform growth rate. However non-uniform growth rate is the most interesting growth rate and can be estimated by considering different swift rate patterns.

Variations of this approach assume a certain level of growth over some initial phase and different growth rates after the initial phase. The finite growth model assumes that the firm will expertise growth of g = (1 – k) r* for n years. After that point, the abnormal investment opportunities of r* will not exist. The value of equity for such a firm will equal:

  • P0 = E1 + E1 g – r (1 – k) [1 – (1 + g) “}
  • R r-g 1 + g

Other models commonly referred to as three phase models assume an initial phase 1 high abnormal growth rate ga for a number of years that tapers off (in phase 2) to a long term phase 3 normal growth patters of gn. If we stay with the definitions of ga as the initial growth pattern and gn as the long term growth pattern to reached within n years, the value of the equity is equal to:

  • P 0 = k E 0 [(1 + gn) + n/2 (ga – gn) }]
  • r – gn

Measure of the risks of the shareholders

In measuring the risk of a security, the shareholders normally looks at the return of the shares. However the return alone is not the only factor considered but they also consider the attitude of the shareholders towards risks. In calculating risks of a security, Beta is considered and it is a measurement of the volatility of the share price of the company. The higher the beta the riskier the securities as well as the higher return it has. Individual investors will like to know the amount of risk associated with the share by looking at the beta available from the company’s trading results.

Because different investors have different preference towards risks there is no acceptable way of measuring risk for all investors. For risk averse investors as the required rate of return increases, there is an increase in risk while risk takers as the required rate of return decreases there is an increase in risk. This is where various risks including market risk, political risk, interest rate risk, purchasing power risk are considered.

For this company, there is a political and foreign exchange risk because the company is trading in various companies. This increases the risk for the investors not getting a constant profit. However for an investor who wants to have a maximum risk diversification he must assess the risk of this company and the average risk of the portfolio being held in order, to spread the risk across the investment.

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Is share over valued or undervalued

The shares of a company are said to be overvalued or undervalues if the market share price is not equal to the book value. It is undervalued when the book value, is higher than the market rate. While it is over valued if the market price is higher than the book value of the company. For this company its share price, have been falling from time to time because of the negative annual report which discloses losses and non-payment of dividends. This information influences the holding, selling, and purchasing shares of the company. Looking at the financial statement of this company I will definitely state that the shares of this company are overvalued because the company is making losses. And when a company is making looses its share price continually goes down. Using price earning ratio you will find the intrinsic value of the share, to be a negative because the earning ratio is a negative but the share price is positive of 0.01 as at the 2nd January 2009. This implies that it is higher than the intrinsic value thus the shares are overvalued.

Influence of share on performance of portfolio

Portfolio is always a diversified investment aimed at minimizing the risk, of investments. The combination of various securities such as stocks bonds and treasury bills forms a portfolio and each of the assets has its own risk. The inclusion of the shares of Pacrim energy limited into a portfolio of more than 10 securities will be negligible but in a portfolio of three or four assets or securities will have a major impact. The share itself has a negative impact on the returns of the portfolio meaning that there is a negative effect in the returns of the portfolio.

Conclusion

This company is a mining company which was initially dealing with oil and gas. However, the company has diversified its principle activities to include gold exploration. The company has been making losses for the last few years including the year 2005 and 2006 under this case study. From the analysis carried above, the shareholder who is interested in the profit should sell the shares because there are no returns. However for shareholders who are interested in future returns should hold the share because it is over valued. It is necessary at this point to state that the shares of Pacrim Energy limited are not a good investment because of the risk that is involved from the beta of the company. The inclusion of this share into a portfolio will be of a higher risk.

References

Brealey R. Myres, S. and Marcus, J. (2001) Fundamentals of corporate Finance, Irwin series in finance, Boston, MA: Irwin/ McGraw – Hill.

Doherty, N.A (2000) Integrated risk Management: Techniques and strategies for managing corporate risk, New York: McGraw – Hill.

Fischer D. E. and Jordan R.J. (2006); Security analysis and Portfolio management, Prentice-Hall, India.

Gershon M., and S. Ghon Rhee, (1984) “The impact of the Degrees of Operating and Financial Leverage on Systematic risk of Common Stock,” Journal of Financial and Quantitative Analysis.

McLane E., (2003; Business finance theory and practice; Prentice Hall ISBN 0-273-67356-4 Available at www.booksites.net.

Schlosser M. ;( 2002); Business finance: application, Models and cases, prentice hall.

Sterling, Robert R, (1970) Theory of the Measurement of Enterprise Income. Lawrence, KS: University Press of Kansas.

Westerfield R., Jaffe, and Jordan (2007); Corporate finance core principles and applications; McGraw-Hill.

White G. I. and Sondhi A. C. and Fried D.; (1997) The Analysis and Use of Financial statements; Wiley Dryden Press.

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