Yahoo Finance Is ConocoPhillips (NYSE:COP) Expensive For A Reason? A Look At Its Intrinsic Value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of ConocoPhillips (NYSE:COP) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
View our latest analysis for ConocoPhillips
The calculation
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF ($, Millions) | US$1.41b | US$2.37b | US$2.99b | US$2.97b | US$2.97b | US$3.00b | US$3.03b | US$3.08b | US$3.13b | US$3.19b |
Growth Rate Estimate Source | Analyst x9 | Analyst x7 | Analyst x3 | Analyst x3 | Est @ 0.15% | Est @ 0.77% | Est @ 1.21% | Est @ 1.51% | Est @ 1.72% | Est @ 1.87% |
Present Value ($, Millions) Discounted @ 9.9% | US$1.3k | US$2.0k | US$2.3k | US$2.0k | US$1.9k | US$1.7k | US$1.6k | US$1.4k | US$1.3k | US$1.2k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$17b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 have used the 5-year average of the 10-year government bond yield (2.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 9.9%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$3.2b× (1 + 2.2%) ÷ (9.9%– 2.2%) = US$43b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$43b÷ ( 1 + 9.9%)10= US$17b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$33b. 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$41.8, the company appears potentially overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
The assumptions
Now 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 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 accounts for debt. In this calculation we've used 9.9%, which is based on a levered beta of 1.274. 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.
Next Steps:
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price exceeding the intrinsic value? For ConocoPhillips, we've compiled three important aspects you should explore:
Risks: Be aware that ConocoPhillips is showing 4 warning signs in our investment analysis , you should know about...
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for COP's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 US stock every day, so if you want to find the intrinsic value of any other stock just search here.
This article by Simply Wall St is general in nature. 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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