Are Baytex Energy Corp. (TSE:BTE) Investors Paying Above The Intrinsic Value?

Key Insights

• Baytex Energy's estimated fair value is CA$4.9 based on 2 Stage Free Cash Flow to Equity
• Current share price of CA$6.2 suggests Baytex Energy is 27% overvalued
• Analyst price target for BTE is CA$8.98 which is 84% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of Baytex Energy Corp. (TSE:BTE) by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Baytex Energy

The Calculation

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 begin with, we have to get estimates of the next ten years of cash flows. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (CA$, Millions)	CA$611.6m	CA$607.0m	CA$278.0m	CA$214.4m	CA$181.2m	CA$162.4m	CA$151.5m	CA$145.1m	CA$141.6m	CA$139.9m
Growth Rate Estimate Source	Analyst x5	Analyst x3	Analyst x1	Est @ -22.87%	Est @ -15.50%	Est @ -10.35%	Est @ -6.74%	Est @ -4.21%	Est @ -2.44%	Est @ -1.20%
Present Value (CA$, Millions) Discounted @ 9.4%	CA$559	CA$507	CA$212	CA$150	CA$116	CA$94.7	CA$80.8	CA$70.7	CA$63.1	CA$57.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$1.9b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 9.4%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CA$140m× (1 + 1.7%) ÷ (9.4%– 1.7%) = CA$1.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$1.8b÷ ( 1 + 9.4%)¹⁰= CA$751m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CA$2.7b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$6.2, the company appears slightly overvalued at the time of writing. 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Baytex Energy 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 9.4%, which is based on a levered beta of 1.384. 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 Baytex Energy

Moving On:

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. Can we work out why the company is trading at a premium to intrinsic value? For Baytex Energy, we've put together three further aspects you should look at:

1. Risks: For example, we've discovered 3 warning signs for Baytex Energy (1 can't be ignored!) that you should be aware of before investing here.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for BTE's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. Simply Wall St updates its DCF calculation for every Canadian stock every day, so if you want to find the intrinsic value of any other stock 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.