NuVista Energy Ltd. (TSE:NVA) Shares Could Be 41% Below Their Intrinsic Value Estimate

Key Insights

• The projected fair value for NuVista Energy is CA$21.70 based on 2 Stage Free Cash Flow to Equity
• Current share price of CA$12.77 suggests NuVista Energy is potentially 41% undervalued
• Analyst price target for NVA is CA$17.23 which is 21% below our fair value estimate

In this article we are going to estimate the intrinsic value of NuVista Energy Ltd. (TSE:NVA) by projecting its future cash flows and then discounting them to today's 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for NuVista Energy

The Calculation

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. 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.

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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CA$, Millions)	CA$223.0m	CA$223.5m	CA$221.1m	CA$221.0m	CA$222.4m	CA$224.9m	CA$228.2m	CA$232.1m	CA$236.5m	CA$241.2m
Growth Rate Estimate Source	Analyst x4	Analyst x2	Est @ -1.06%	Est @ -0.06%	Est @ 0.64%	Est @ 1.13%	Est @ 1.47%	Est @ 1.71%	Est @ 1.88%	Est @ 2.00%
Present Value (CA$, Millions) Discounted @ 6.8%	CA$209	CA$196	CA$182	CA$170	CA$160	CA$152	CA$144	CA$137	CA$131	CA$125

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$1.6b

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CA$241m× (1 + 2.3%) ÷ (6.8%– 2.3%) = CA$5.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CA$5.5b÷ ( 1 + 6.8%)¹⁰= CA$2.8b

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$4.5b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CA$12.8, the company appears quite undervalued at a 41% discount to where the stock price trades currently. 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.

Important Assumptions

We would point out that 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 NuVista 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 6.8%, which is based on a levered beta of 1.092. 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 NuVista Energy

Looking Ahead:

Although the valuation of a company is important, it 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 discount to intrinsic value? For NuVista Energy, we've put together three additional aspects you should consider:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with NuVista Energy , and understanding it should be part of your investment process.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for NVA'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.

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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.