How far off is Pioneer Energy Services (NYSE:PES) to its intrinsic value? I am going to take a look now using a method called discounted cash flow or DCF. Discounted Cash Flow or DCF is a direct valuation technique that values a company by projecting its future cash flows and then discounting them to todays money. It sounds complicated, but actually it is quite simple!

If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model.If you are reading this and its not January 2017 then I highly recommend you check out the latest calculation for Pioneer Energy Services by following the link below. View our latest analysis for Pioneer Energy Services

I use what is known as a 2-stage model, which simply means we have two different periods where we need to estimate cash flows. In the 1st stage we need to estimate the cash flows to the business over the next 5 years, where possible I use analysts estimates but when these aren’t available I have extrapolated the previous Free Cash Flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past 5 years, but capped to a reasonable level. I then discount the sum of these cash flows to arrive at a present value estimate.

### The calculation

Please note that the numbers here are in millions apart from the per share values.

#### 5-year cash flow estimate

2017 | 2018 | 2019 | 2020 | 2021 | |

Levered FCF (USD, Millions) | $-7.05 | $33.37 | $79.50 | $103.20 | $83.90 |

Source | Analyst x2 | Analyst x3 | Analyst x1 | Analyst x1 | Extrapolated @ (-18.7%) |

Present Value Discounted @ 13.97% | $-6.19 | $25.69 | $53.70 | $61.17 | $43.63 |

Present value of next 5 years cash flows: $178

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the 5 years. The Perpetuity Method (Gordon Formula) is used to calculate Terminal Value at an annual growth rate equal to the 10 year government bond rate of (1.8%).

#### Terminal Value

Terminal Value = FCF_{2021} × (1 + g) ÷ (Discount Rate – g)

Terminal Value = $84 × (1 + 1.8%) ÷ (14% – 1.8%)

Terminal value based on the Perpetuity Method where growth (g) = 1.8%: $699

**Present value of terminal value: $363**

So the total value is the sum of the next 5 years cash flows and the terminal value discounted to today, this is known as the Equity Value.

#### Equity Value

Equity Value (Total value) = Present value of next 5 years cash flows + terminal value = $178 + $363 = $541

To get the intrinsic value we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR to get the intrinsic value per share.

Value = Total value / Shares Outstanding ($541.32 / 76.63)

**Value per share: $7.06**

Now when we compare the intrinsic value of 7.06 to the current share price of $6.6 we see Pioneer Energy Services (NYSE:PES) is a touch undervalued at a **7% discount to what it is available for right now**.

### The Assumptions

I’d like to 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Pioneer Energy Services as potential investors the Cost of Equity is used as the discount rate, not the Cost of Capital (or Weighed Average Cost of Capital/ WACC) which accounts for debt.

In this calculation I’ve used 14% and this is based on a Levered Beta of 1.481. I’m not going to go into how I calculate the Levered Beta in detail, I used the ‘Bottom up Beta’ method based on the comparable businesses, I also impose a limit between 0.8 and 2 which is a reasonable range for a stable business. Google this if you want to learn more.

### Final Words

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. Is Pioneer Energy Services in a healthy financial condition? What is the reason for the share price to differ from the intrinsic value?** See our latest FREE analysis to find out!**

PS. The Simply Wall St app conducts a discounted cash flow for every stock on the NYSE every 6 hours. If you want to find the calculation for another other stock just search here.