- Oil and Gas
Estimating The Fair Value Of Enbridge Inc. (TSE:ENB)
- Using the 2 Stage Free Cash Flow to Equity, Enbridge fair value estimate is CA$47.65
- Enbridge's CA$50.38 share price indicates it is trading at similar levels as its fair value estimate
- Our fair value estimate is 22% higher than Enbridge's analyst price target of CA$58.00
Today we will run through one way of estimating the intrinsic value of Enbridge Inc. (TSE:ENB) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
View our latest analysis for Enbridge
Crunching The Numbers
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
|Levered FCF (CA$, Millions)||CA$8.73b||CA$9.14b||CA$8.46b||CA$8.96b||CA$9.82b||CA$10.1b||CA$10.3b||CA$10.5b||CA$10.7b||CA$10.9b|
|Growth Rate Estimate Source||Analyst x5||Analyst x5||Analyst x3||Analyst x3||Analyst x2||Est @ 2.49%||Est @ 2.27%||Est @ 2.12%||Est @ 2.01%||Est @ 1.94%|
|Present Value (CA$, Millions) Discounted @ 11%||CA$7.9k||CA$7.4k||CA$6.2k||CA$5.9k||CA$5.8k||CA$5.3k||CA$4.9k||CA$4.5k||CA$4.1k||CA$3.8k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$56b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 11%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CA$11b× (1 + 1.8%) ÷ (11%– 1.8%) = CA$118b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$118b÷ ( 1 + 11%)10= CA$41b
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$96b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$50.4, the company appears around fair value 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.
Now 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 Enbridge 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 11%, which is based on a levered beta of 1.588. 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 Enbridge
- Dividend is in the top 25% of dividend payers in the market.
- Earnings declined over the past year.
- Interest payments on debt are not well covered.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow faster than the Canadian market.
- Significant insider buying over the past 3 months.
- Debt is not well covered by operating cash flow.
- Dividends are not covered by earnings and cashflows.
- Annual revenue is forecast to grow slower than the Canadian market.
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Enbridge, we've compiled three pertinent factors you should assess:
- Risks: For example, we've discovered 4 warning signs for Enbridge (2 are concerning!) that you should be aware of before investing here.
- Future Earnings: How does ENB'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.
- 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 Canadian stock every day, so if you want to find the intrinsic value of any other stock just search here.
Valuation is complex, but we're helping make it simple.
Find out whether Enbridge is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.
Enbridge Inc., together with its subsidiaries, operates as an energy infrastructure company.
Average dividend payer with limited growth.