Using earnings multiples to value companies

Using earnings multiples for valuing companies with finite life assets can cause potential issues especially as those life assets approach the end of their useful life.

Let’s use an example to illustrate this point. During the 2018 June quarter production reporting season, a number of mining companies recorded steep share price falls, one of which was Sandfire Resources (ASX:SFR) – a mid-cap copper producer. With the share price of its direct peers being relatively stable, it appeared the sell-off was due to a stock specific issue rather than a drop in the copper price.

So what prompted the selling?

Analysts pointed to Sandfire’s American subsidiary conducting a rights issue, as well as a delay in developing a high-grade section of the orebody as potential catalysts. But in this case, the fall must be put into context relative to its share price at the time, and what it was implying for future earnings.

Prior to the release of the 2018 June quarter report, Sandfire’s $9 share price implied an expected 2019 PE ratio of 9x and an EV to EBITDA multiple of 3.7x. While these headline multiples appear very cheap for a quality copper asset, any earnings multiples should be referenced to the remaining life of its assets when assessing its investment merits.

In the case of Sandfire, the company’s Resources and Reserves Statement suggests a mine life of less than 4 years without further exploration success. Within this context, a price to earnings ratio of 9x appears high when its earnings may not be repeated more than 4 years into the future.

Taking a different view



A more accurate reference check may be the EBITDA multiple, as EBITDA provides a better representation of a mining asset’s actual cash flow. Sandfire’s prior multiple of 3.7x compared favourably to its remaining mine-life of about 4 years. However, what the EBITDA fails to capture is the cash-outflows associated with tax, sustaining capital and any unfunded remediation liabilities.

It is important to account for an estimate of these items as they may have a material impact on the remaining cash available for shareholders at the end of the useful life.