Stock Analysis

Estimating The Intrinsic Value Of Enerplus Corporation (TSE:ERF)

TSX:ERF
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Key Insights

  • Enerplus' estimated fair value is US$27.2 based on 2 Stage Free Cash Flow to Equity
  • Current share price of US$22.7 suggests Enerplus is trading close to its fair value

Does the February share price for Enerplus Corporation (TSE:ERF) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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 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 Enerplus

What's The Estimated Valuation?

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$608.2m US$435.3m US$396.0m US$372.9m US$359.6m US$352.5m US$349.4m US$349.0m US$350.5m US$353.3m
Growth Rate Estimate Source Analyst x7 Analyst x4 Est @ -9.03% Est @ -5.81% Est @ -3.56% Est @ -1.99% Est @ -0.88% Est @ -0.11% Est @ 0.43% Est @ 0.81%
Present Value ($, Millions) Discounted @ 9.2% US$557 US$365 US$304 US$263 US$232 US$208 US$189 US$173 US$159 US$147

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.6b

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 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$353m× (1 + 1.7%) ÷ (9.2%– 1.7%) = US$4.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.8b÷ ( 1 + 9.2%)10= US$2.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$4.6b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of CA$22.7, the company appears about fair value at a 17% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
TSX:ERF Discounted Cash Flow February 2nd 2023

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Enerplus 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 9.2%, which is based on a levered beta of 1.245. 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 Enerplus

Strength
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Oil and Gas market.
Opportunity
  • Annual earnings are forecast to grow faster than the Canadian market.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • No apparent threats visible for ERF.

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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 Enerplus, there are three fundamental elements you should assess:

  1. Risks: Take risks, for example - Enerplus has 2 warning signs we think you should be aware of.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ERF's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. 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 Enerplus 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.

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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.