Calculating The Intrinsic Value Of Australis Oil & Gas Limited (ASX:ATS)

Key Insights

• Australis Oil & Gas' estimated fair value is AU$0.047 based on 2 Stage Free Cash Flow to Equity
• Australis Oil & Gas' AU$0.042 share price indicates it is trading at similar levels as its fair value estimate
• Peers of Australis Oil & Gas are currently trading on average at a 19% premium

In this article we are going to estimate the intrinsic value of Australis Oil & Gas Limited (ASX:ATS) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

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 Australis Oil & Gas

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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$3.44m	US$3.34m	US$3.29m	US$3.28m	US$3.29m	US$3.32m	US$3.35m	US$3.40m	US$3.45m	US$3.51m
Growth Rate Estimate Source	Est @ -4.85%	Est @ -2.81%	Est @ -1.39%	Est @ -0.39%	Est @ 0.30%	Est @ 0.79%	Est @ 1.13%	Est @ 1.37%	Est @ 1.54%	Est @ 1.66%
Present Value ($, Millions) Discounted @ 9.8%	US$3.1	US$2.8	US$2.5	US$2.3	US$2.1	US$1.9	US$1.7	US$1.6	US$1.5	US$1.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$21m

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 (1.9%) 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 9.8%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$3.5m× (1 + 1.9%) ÷ (9.8%– 1.9%) = US$46m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$46m÷ ( 1 + 9.8%)¹⁰= US$18m

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$39m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$0.04, the company appears about fair value at a 10% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

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 Australis Oil & Gas 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 9.8%, which is based on a levered beta of 1.318. 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 Australis Oil & Gas

Looking Ahead:

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. 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. For Australis Oil & Gas, we've put together three important aspects you should assess:

1. Risks: You should be aware of the 4 warning signs for Australis Oil & Gas (1 is potentially serious!) we've uncovered before considering an investment in the company.
2. Future Earnings: How does ATS'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 ASX every day. If you want to find the calculation for other stocks just search here.

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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.