Chevron Corporation's (NYSE:CVX) Intrinsic Value Is Potentially 25% Above Its Share Price

Key Insights

• Chevron's estimated fair value is US$194 based on 2 Stage Free Cash Flow to Equity

• Chevron's US$156 share price signals that it might be 20% undervalued

• Analyst price target for CVX is US$186 which is 4.1% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Chevron Corporation (NYSE:CVX) by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Chevron

The Method

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$26.1b	US$28.3b	US$28.1b	US$28.1b	US$28.3b	US$28.6b	US$29.0b	US$29.5b	US$30.0b	US$30.5b
Growth Rate Estimate Source	Analyst x11	Analyst x12	Analyst x5	Est @ 0.06%	Est @ 0.67%	Est @ 1.11%	Est @ 1.41%	Est @ 1.62%	Est @ 1.77%	Est @ 1.87%
Present Value ($, Millions) Discounted @ 9.1%	US$23.9k	US$23.8k	US$21.6k	US$19.8k	US$18.3k	US$17.0k	US$15.8k	US$14.7k	US$13.7k	US$12.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$181b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 9.1%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$31b× (1 + 2.1%) ÷ (9.1%– 2.1%) = US$447b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$447b÷ ( 1 + 9.1%)¹⁰= US$187b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$368b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$156, the company appears a touch undervalued at a 20% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

The Assumptions

We would point out 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 inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Chevron 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 accounts for debt. In this calculation we've used 9.1%, which is based on a levered beta of 1.176. Beta is a measure of a stock's volatility, compared 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.

SWOT Analysis for Chevron

Strength

• Earnings growth over the past year exceeded its 5-year average.

• Debt is not viewed as a risk.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings growth over the past year underperformed the Oil and Gas industry.

• Dividend is low compared to the top 25% of dividend payers in the Oil and Gas market.

Opportunity

• Trading below our estimate of fair value by more than 20%.

Threat

• Annual earnings are forecast to decline for the next 3 years.

Next Steps:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For Chevron, we've put together three important factors you should further research:

1. Risks: Every company has them, and we've spotted 1 warning sign for Chevron you should know about.

2. Future Earnings: How does CVX's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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