How far is Helmerich & Payne, Inc. (NYSE: HP) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking the company’s expected future cash flows and discounting them to their present value. The DCF (Discounted Cash Flow) model is the tool we will apply to do this. It may sound complicated, but it’s actually quite simple!

Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. Anyone interested in learning a little more about intrinsic value should have a read of the Simply Wall St.

What is the estimated valuation?

We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of these future cash flows is then discounted to present value:

10-year Free Cash Flow (FCF) forecast

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 1.3 billion USD

Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount terminal cash flows to their present value at a cost of equity of 11%.

Terminal value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = $ 352 million × (1 + 2.0%) ÷ (11% – 2.0%) = $ 4.2 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= 4.2 billion USD ÷ (1 + 11%)^ten= 1.5 billion USD

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 2.8 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of US $ 26.4, the company appears to be around fair value at the time of writing. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.

NYSE: HP Discounted Cash Flow April 20, 2021

The hypotheses

Now the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Helmerich & Payne as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which takes debt into account. In this calculation, we used 11%, which is based on a leveraged beta of 1.648. Beta is a measure of the volatility of a stock, relative to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Looking forward:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a business. It is not possible to obtain an infallible valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Helmerich & Payne, we’ve compiled three relevant aspects that you should consider:

1. Risks: Take risks, for example – Helmerich & Payne has 3 warning signs (and 1 which is of concern) we think you should know.
2. Management: Insiders Have They Raised Their Shares To Take Advantage Of Market Sentiment For HP’s Future Outlook? Check out our management and board analysis with information on CEO compensation and governance factors.
3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high quality inventory to get a feel for what you might be missing!

PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock just search here.

This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.