Yahoo Finance A Look At The Fair Value Of Meridian Energy Limited (NZSE:MEL)
I am going to run you through how I calculated the intrinsic value of Meridian Energy Limited (NZSE:MEL) by projecting its future cash flows and then discounting them to today’s value. I will use the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not August 2018 then I highly recommend you check out the latest calculation for Meridian Energy by following the link below.
View our latest analysis for Meridian Energy
The method
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow estimate
2018 | 2019 | 2020 | 2021 | 2022 | |
Levered FCF (NZ$, Millions) | NZ$427.00 | NZ$477.00 | NZ$477.00 | NZ$464.04 | NZ$451.43 |
Source | Analyst x2 | Analyst x2 | Analyst x1 | Est @ -2.72% | Est @ -2.72% |
Present Value Discounted @ 9.01% | NZ$391.71 | NZ$401.42 | NZ$368.25 | NZ$328.64 | NZ$293.29 |
Present Value of 5-year Cash Flow (PVCF)= NZ$1.78b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 5%. We discount this to today’s value at a cost of equity of 9%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = NZ$451.43m × (1 + 5%) ÷ (9% – 5%) = NZ$11.95b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = NZ$11.95b ÷ ( 1 + 9%)5 = NZ$7.76b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is NZ$9.55b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of NZ$3.73. Compared to the current share price of NZ$3.27, the stock is about right, perhaps slightly undervalued at a 12.25% discount to what it is available for right now.
Important assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Meridian Energy as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 9%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. For MEL, I’ve compiled three key factors you should further examine:
Financial Health: Does MEL have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does MEL’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.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of MEL? 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 does a DCF calculation for every NZ stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
