Calculating the intrinsic value of ConocoPhillips (NYSE: COP)
How far is ConocoPhillips (NYSE: COP) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking expected future cash flows and discounting them to today’s value. Our analysis will use the discounted cash flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
There are many ways businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
What is the estimated valuation?
We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to estimate the next ten years of cash flow. 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 stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of those future cash flows to their estimated value in today’s dollars. hui:
10-year Free Cash Flow (FCF) estimate
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Leverage FCF ($, Millions) | US $ 6.26 billion | 6.46 billion US dollars | US $ 5.92 billion | US $ 5.79 billion | 5.64 billion US dollars | US $ 5.59 billion | US $ 5.58 billion | 5.61 billion US dollars | 5.66 billion US dollars | US $ 5.73 billion |
Source of estimated growth rate | Analyst x11 | Analyst x9 | Analyst x7 | Analyst x3 | Analyst x2 | Is @ -1.02% | East @ -0.11% | Is @ 0.52% | Est @ 0.96% | Est @ 1.27% |
Present value (in millions of dollars) discounted at 8.6% | $ 5.8,000 | 5.5,000 USD | 4.6,000 USD | US $ 4.2k | $ 3.7,000 | 3.4,000 USD | US $ 3.1k | $ 2.9,000 | $ 2.7,000 | $ 2.5,000 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 38 billion
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 8.6%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = US $ 5.7B × (1 + 2.0%) ÷ (8.6% – 2.0%) = US $ 88B
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= US $ 88 billion ÷ (1 + 8.6%)^{ten}= US $ 38 billion
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is $ 77 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current price of US $ 59.7, the company appears to be around fair value at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
NYSE: COP Discounted Cash Flow June 10, 2021
The hypotheses
We draw your attention to the fact that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own 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 full picture of a company’s potential performance. Since we view ConocoPhillips 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 into account debt. In this calculation, we used 8.6%, which is based on a leveraged beta of 1.407. 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 from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
To move on :
Valuation is only one side of the coin in terms of building your investment thesis, and ideally, it won’t be the only piece of analysis you look at for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For ConocoPhillips, we’ve compiled three important aspects that you should research further:
- Risks: For example, we discovered 6 warning signs for ConocoPhillips which you should know before investing here.
- Management: Have insiders increased their shares to take advantage of market sentiment about the future prospects of the COP? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every NYSE share. If you want to find the calculation for other actions, just search here.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is 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 documents. Simply Wall St has no position in the mentioned stocks.
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