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Is Marathon Petroleum Corporation (NYSE:MPC) Trading At A 26% Discount?

Key Insights

  • The projected fair value for Marathon Petroleum is US$144 based on 2 Stage Free Cash Flow to Equity

  • Marathon Petroleum is estimated to be 26% undervalued based on current share price of US$107

  • Analyst price target for MPC is US$149, which is 3.5% above our fair value estimate

In this article we are going to estimate the intrinsic value of Marathon Petroleum Corporation (NYSE:MPC) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

Check out our latest analysis for Marathon Petroleum

Step By Step Through The Calculation

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.

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) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$9.96b

US$7.53b

US$5.59b

US$5.84b

US$6.05b

US$5.80b

US$5.67b

US$5.62b

US$5.62b

US$5.65b

Growth Rate Estimate Source

Analyst x4

Analyst x5

Analyst x2

Analyst x1

Analyst x1

Est @ -4.07%

Est @ -2.21%

Est @ -0.92%

Est @ -0.01%

Est @ 0.63%

Present Value ($, Millions) Discounted @ 11%

US$9.0k

US$6.1k

US$4.1k

US$3.8k

US$3.6k

US$3.1k

US$2.7k

US$2.4k

US$2.2k

US$2.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$39b

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. 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 (2.1%) 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 11%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$5.7b× (1 + 2.1%) ÷ (11%– 2.1%) = US$64b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$64b÷ ( 1 + 11%)10= US$22b

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$61b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$107, the company appears a touch undervalued at a 26% discount to where the stock price trades currently. 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.

dcf
dcf

Important 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. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. 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 Marathon Petroleum 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 11%, which is based on a levered beta of 1.520. 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 Marathon Petroleum

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is well covered by earnings and cashflows.

  • Dividends are covered by earnings and cash flows.

Weakness

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

Opportunity

  • Good value based on P/E ratio and estimated fair value.

Threat

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

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Marathon Petroleum, we've put together three important items you should assess:

  1. Risks: To that end, you should learn about the 2 warning signs we've spotted with Marathon Petroleum (including 1 which can't be ignored) .

  2. Future Earnings: How does MPC'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks 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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