- Oil and Gas
A Look At The Intrinsic Value Of Cenovus Energy Inc. (TSE:CVE)
- Using the 2 Stage Free Cash Flow to Equity, Cenovus Energy fair value estimate is CA$19.64
- With CA$21.73 share price, Cenovus Energy appears to be trading close to its estimated fair value
- The CA$32.56 analyst price target for CVE is 66% more than our estimate of fair value
Today we will run through one way of estimating the intrinsic value of Cenovus Energy Inc. (TSE:CVE) by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
See our latest analysis for Cenovus Energy
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
|Levered FCF (CA$, Millions)||CA$6.21b||CA$6.62b||CA$3.86b||CA$3.17b||CA$3.52b||CA$2.96b||CA$2.65b||CA$2.47b||CA$2.36b||CA$2.30b|
|Growth Rate Estimate Source||Analyst x9||Analyst x8||Analyst x2||Analyst x1||Analyst x1||Est @ -15.81%||Est @ -10.54%||Est @ -6.85%||Est @ -4.27%||Est @ -2.46%|
|Present Value (CA$, Millions) Discounted @ 9.4%||CA$5.7k||CA$5.5k||CA$2.9k||CA$2.2k||CA$2.2k||CA$1.7k||CA$1.4k||CA$1.2k||CA$1.1k||CA$939|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$25b
The second stage is also known as Terminal Value, this is the business's cash flow after 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 (1.8%) 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 9.4%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CA$2.3b× (1 + 1.8%) ÷ (9.4%– 1.8%) = CA$31b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$31b÷ ( 1 + 9.4%)10= CA$13b
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 CA$37b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$21.7, the company appears around fair value at the time of writing. 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Cenovus 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 1.285. 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 Cenovus Energy
- Earnings growth over the past year exceeded the industry.
- Debt is not viewed as a risk.
- Dividends are covered by earnings and cash flows.
- Dividend is low compared to the top 25% of dividend payers in the Oil and Gas market.
- Good value based on P/E ratio compared to estimated Fair P/E ratio.
- Significant insider buying over the past 3 months.
- Annual earnings are forecast to decline for the next 3 years.
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize 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?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Cenovus Energy, we've compiled three additional factors you should explore:
- Risks: Every company has them, and we've spotted 2 warning signs for Cenovus Energy (of which 1 is concerning!) you should know about.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CVE's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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.
Cenovus Energy Inc., together with its subsidiaries, develops, produces, refines, transports, and markets crude oil and natural gas in Canada and internationally.
Outstanding track record with excellent balance sheet.