The intrinsic value of Woodside Energy Group Ltd (ASX:WDS) is potentially 41% higher than its share price
Today we’ll walk through one way to estimate the intrinsic value of Woodside Energy Group Ltd (ASX:WDS) by taking expected future cash flows and discounting them to the present value. We will use the Discounted Cash Flow (DCF) model for this purpose. This may sound complicated, but it’s actually quite simple!
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Our analysis indicates that WDS is potentially undervalued!
The method
We use what is called a 2-step model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To start, we need to estimate the cash flows for 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 discount the value of these future cash flows to their estimated value in today’s dollars:
Estimated free cash flow (FCF) over 10 years
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF ($, millions) | $3.86 billion | $2.95 billion | $3.83 billion | US$4.57 billion | $4.85 billion | US$5.09 billion | US$5.29 billion | $5.47 billion | $5.63 billion | $5.77 billion |
Growth rate estimate Source | Analyst x5 | Analyst x5 | Analyst x2 | Analyst x2 | Is at 6.13% | Is at 4.85% | Is at 3.96% | East @ 3.33% | Is at 2.89% | Is at 2.59% |
Present value (millions of dollars) discounted at 8.5% | $3,600 | $2.5,000 | $3,000 | $3,300 | $3,200 | $3,100 | $3,000 | $2.8,000 | $2.7,000 | $2.5,000 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $30 billion
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which 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 (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 8.5%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = $5.8 billion × (1 + 1.9%) ÷ (8.5%–1.9%) = $88 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $88 billion ÷ (1 + 8.5%)^{ten}= $39 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $69 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 AU$38.5, the company looks slightly undervalued at a 29% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the 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, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Woodside Energy Group 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 8.5%, which is based on a leveraged beta of 1.295. 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.
Look forward:
Although a business valuation is important, it is only one of many factors you need to assess for a business. The DCF model is not a perfect stock valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. Can we understand why the company is trading at a discount to its intrinsic value? For Woodside Energy Group, there are three key elements that you should examine in more detail:
- Risks: For example, we found 4 warning signs for Woodside Energy Group (2 should not be ignored!) that you should consider before investing here.
- Future earnings: How does WDS’ growth rate compare to its peers and the broader market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every Australian stock daily, so if you want to find the intrinsic value of any other stock, just search here.
Valuation is complex, but we help make it simple.
Find out if Woodside Energy Group 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.