Stock Analysis

A Look At The Fair Value Of Gibson Energy Inc. (TSE:GEI)

TSX:GEI
Source: Shutterstock

Key Insights

  • The projected fair value for Gibson Energy is CA$18.78 based on 2 Stage Free Cash Flow to Equity
  • With CA$20.54 share price, Gibson Energy appears to be trading close to its estimated fair value
  • Our fair value estimate is 25% lower than Gibson Energy's analyst price target of CA$24.96

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Gibson Energy Inc. (TSE:GEI) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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.

See our latest analysis for Gibson Energy

The Model

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF (CA$, Millions) CA$400.8m CA$440.7m CA$280.0m CA$291.0m CA$264.3m CA$248.9m CA$240.1m CA$235.4m CA$233.6m CA$233.6m
Growth Rate Estimate Source Analyst x4 Analyst x3 Analyst x1 Analyst x1 Est @ -9.16% Est @ -5.85% Est @ -3.54% Est @ -1.92% Est @ -0.79% Est @ 0.01%
Present Value (CA$, Millions) Discounted @ 9.9% CA$365 CA$365 CA$211 CA$200 CA$165 CA$142 CA$124 CA$111 CA$100 CA$91.2

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

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 9.9%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CA$234m× (1 + 1.9%) ÷ (9.9%– 1.9%) = CA$3.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$3.0b÷ ( 1 + 9.9%)10= CA$1.2b

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$3.0b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$20.5, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
TSX:GEI Discounted Cash Flow November 2nd 2023

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 Gibson 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 9.9%, which is based on a levered beta of 1.600. 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 Gibson Energy

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings.
  • Dividend is in the top 25% of dividend payers in the market.
Weakness
  • Earnings growth over the past year is below its 5-year average.
  • Expensive based on P/E ratio and estimated fair value.
  • Shareholders have been diluted in the past year.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
Threat
  • Debt is not well covered by operating cash flow.
  • Dividends are not covered by earnings.
  • Annual earnings are forecast to grow slower than the Canadian market.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Gibson Energy, we've compiled three relevant elements you should look at:

  1. Risks: For example, we've discovered 3 warning signs for Gibson Energy (1 makes us a bit uncomfortable!) 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 GEI'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.

New: Manage All Your Stock Portfolios in One Place

We've created the ultimate portfolio companion for stock investors, and it's free.

• Connect an unlimited number of Portfolios and see your total in one currency
• Be alerted to new Warning Signs or Risks via email or mobile
• Track the Fair Value of your stocks

Try a Demo Portfolio for Free

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.