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Are Pioneer Natural Resources Company (NYSE:PXD) Investors Paying Above The Intrinsic Value?

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Pioneer Natural Resources Company (NYSE:PXD) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Pioneer Natural Resources

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$4.91b

US$4.29b

US$3.44b

US$3.94b

US$3.72b

US$3.59b

US$3.53b

US$3.50b

US$3.51b

US$3.53b

Growth Rate Estimate Source

Analyst x11

Analyst x9

Analyst x4

Analyst x2

Est @ -5.72%

Est @ -3.41%

Est @ -1.8%

Est @ -0.66%

Est @ 0.13%

Est @ 0.69%

Present Value ($, Millions) Discounted @ 8.5%

US$4.5k

US$3.6k

US$2.7k

US$2.8k

US$2.5k

US$2.2k

US$2.0k

US$1.8k

US$1.7k

US$1.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$25b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.0%) 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 8.5%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$3.5b× (1 + 2.0%) ÷ (8.5%– 2.0%) = US$55b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$55b÷ ( 1 + 8.5%)10= US$25b

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$50b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$254, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
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 Pioneer Natural Resources 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 8.5%, which is based on a levered beta of 1.266. 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:

Although the valuation of a company is important, it 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. 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 Pioneer Natural Resources, we've compiled three fundamental factors you should look at:

  1. Risks: Case in point, we've spotted 2 warning signs for Pioneer Natural Resources you should be aware of, and 1 of them doesn't sit too well with us.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for PXD's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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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