The intrinsic value of Oil and Natural Gas Corporation Limited (NSE:ONGC) is potentially 63% higher than its share price
How far is Oil and Natural Gas Corporation Limited (NSE:ONGC) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the company’s expected future cash flows and discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
Check out our latest analysis for oil and natural gas
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.
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 these future cash flows to their estimated value in today’s dollars:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF (₹, million)||₹336.0b||₹410.9b||₹388.5 billion||₹423.7 billion||₹459.1b||₹495.2b||₹532.5 billion||₹571.3b||₹612.0b||₹654.8 billion|
|Growth rate estimate Source||Analyst x6||Analyst x7||Analyst x7||Is at 9.05%||Is at 8.36%||Is at 7.87%||Is at 7.53%||Is at 7.29%||Is at 7.12%||Is at 7%|
|Present value (₹, million) discounted at 17%||₹287,800||₹301,600||₹244,300||₹228,200||₹211,800||₹195,800||₹180,300||₹165,700||₹152,100||₹139,400|
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 6.7%. We discount terminal cash flows to present value at a cost of equity of 17%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₹655b × (1 + 6.7%) ÷ (17%–6.7%) = ₹7.0t
Present value of terminal value (PVTV)= TV / (1 + r)ten= ₹7.0t÷ ( 1 + 17%)ten= ₹1.5t
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is ₹3.6t. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of ₹176, the company appears to be pretty good value with a 38% discount to where the share price is currently trading. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you disagree with these results, try the math yourself and play around 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 consider oil and natural gas 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 the debt. In this calculation, we used 17%, which is based on a leveraged beta of 1.558. 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.
Let’s move on :
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. 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 significantly change the overall result. Why is the stock price below intrinsic value? For oil and natural gas, there are three essentials you need to explore:
- Risks: For example, we found 2 oil and natural gas warning signs that you must consider before investing here.
- Future earnings: How does ONGC’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. Simply Wall St updates its DCF calculation for every Indian stock every day, so if you want to find the intrinsic value of any other stock, just search here.
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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.