Is there an opportunity with Dorian LPG Ltd’s 32% undervaluation? (NYSE:LPG)?
In this article, we are going to estimate the intrinsic value of Dorian LPG Ltd. (NYSE: LPG) by projecting its future cash flows and then discounting them to present value. Our analysis will use the discounted cash flow (DCF) model. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
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The method
We will use a two-stage 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 “sustained growth”. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
10-Year Free Cash Flow (FCF) Forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF ($, millions) | $85.0 million | $110.0 million | $103.5 million | $99.8 million | $98.0 million | $97.3 million | $97.3 million | $98.0 million | $99.0 million | $100.3 million |
Growth rate estimate Source | Analyst x1 | Analyst x1 | Is @ -5.9% | Is @ -3.54% | Is @ -1.88% | Is @ -0.72% | Is at 0.09% | Is at 0.66% | Is at 1.05% | Is at 1.33% |
Present value (in millions of dollars) discounted at 10% | $76.9 | $90.1 | $76.7 | $67.0 | $59.5 | $53.4 | $48.4 | $44.1 | $40.3 | $37.0 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $593 million
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 stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 2.0%. We discount terminal cash flows to present value at a cost of equity of 10%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = US$100 million × (1 + 2.0%) ÷ (10%–2.0%) = US$1.2 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $1.2 billion ÷ (1 + 10%)^{ten}= $443 million
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $1.0 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $17.6, the company looks quite undervalued at a 32% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
Important assumptions
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. 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 consider DorianG 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 10%, which is based on a leveraged beta of 1.820. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Next steps:
While a business valuation is important, it shouldn’t be the only metric to consider 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 the company being undervalued or overvalued. If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. Can we understand why the company is trading at a discount to its intrinsic value? For DorianG, there are three fundamental elements that you should examine in more detail:
- Risks: You should be aware of the 3 warning signs for DorianG we found out before considering an investment in the business.
- Future earnings: How does LPG’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. The Simply Wall St app performs a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, search here.
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Find out if DorianG is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.