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Financial Times: Lex Column: Pricey BG

Published: November 2 2007 02:00 | Last updated: November 2 2007 02:00

There’s reassuringly expensive, and there’s just plain expensive. Which is BG? Spun out of British Gas a decade ago, the oil and gas explorer has consistently commanded a premium rating to peers, largely on the strength of its sector-leading reserve life rates, vibrant liquefied natural gas operations, and one of the least gaffe-prone management teams in the business. These days it is at the upper end of that historic premium range, trading on 12 times forward enterprise value to debt-adjusted cash flow, almost 60 per cent above its rivals, and about 40 per cent higher on p/e.

Yesterday’s third-quarter figures did nothing to knock BG off its perch. Production losses caused by a rupture to a key pipeline had been well telegraphed as due to force majeure . More good news from the LNG unit – profits up 129 per cent year on year as prices for spot cargoes soared – also strengthened the bull case.

But there are grounds for restraint. The most obvious way to justify a much higher valuation for BG is to insert into a model the kind of oil prices indicated by futures strips, which are about $80 a barrel all the way out to 2015. Otherwise, it demands keeping faith with management’s estimates of yearly volume growth of between 5 and 6 per cent to the end of the decade, and possibly higher after that – in both cases, way above the majors. In fairness, BG has delivered on its promises in the past. But it does appear less bothered than rivals about the so-called “PSC effect”, by which profit declines with higher oil prices under production-sharing contracts with host governments.

There is also an element of takeover speculation in the stretched multiples, which may not be warranted. However tempting its assets, BG’s £31bn market capitalisation now rules out most lone predators while a large premium would be hard to justify for even joint bidders such as Shell and Petrobras. BG should remain the darling of the sector, but investors should be wary of passions overheating.

Copyright The Financial Times Limited 2007

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