- Oil and Gas
A Look At The Fair Value Of Oil and Natural Gas Corporation Limited (NSE:ONGC)
- The projected fair value for Oil and Natural Gas is ₹158 based on 2 Stage Free Cash Flow to Equity
- With ₹153 share price, Oil and Natural Gas appears to be trading close to its estimated fair value
- The ₹180 analyst price target for ONGC is 14% more than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Oil and Natural Gas Corporation Limited (NSE:ONGC) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for Oil and Natural Gas
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. 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
|Levered FCF (₹, Millions)||₹225.8b||₹384.7b||₹386.2b||₹395.1b||₹409.6b||₹428.5b||₹451.0b||₹476.9b||₹505.7b||₹537.5b|
|Growth Rate Estimate Source||Analyst x6||Analyst x6||Analyst x6||Est @ 2.31%||Est @ 3.66%||Est @ 4.60%||Est @ 5.27%||Est @ 5.73%||Est @ 6.05%||Est @ 6.28%|
|Present Value (₹, Millions) Discounted @ 22%||₹184.9k||₹257.8k||₹211.9k||₹177.5k||₹150.6k||₹129.0k||₹111.2k||₹96.2k||₹83.5k||₹72.7k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹1.5t
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 (6.8%) 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 22%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = ₹537b× (1 + 6.8%) ÷ (22%– 6.8%) = ₹3.7t
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹3.7t÷ ( 1 + 22%)10= ₹506b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹2.0t. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of ₹153, the company appears about fair value at a 2.8% discount to where the stock price trades currently. 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.
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. 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 Oil and Natural Gas 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 22%, which is based on a levered beta of 1.576. 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 Oil and Natural Gas
- Debt is well covered by earnings and cashflows.
- Dividends are covered by earnings and cash flows.
- Dividend is in the top 25% of dividend payers in the market.
- Earnings declined over the past year.
- Annual earnings are forecast to grow for the next 3 years.
- Good value based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow slower than the Indian market.
Although the valuation of a company is important, 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Oil and Natural Gas, we've put together three fundamental factors you should further examine:
- Risks: For instance, we've identified 3 warning signs for Oil and Natural Gas that you should be aware of.
- Future Earnings: How does ONGC'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 Indian 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.
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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.
Oil and Natural Gas
Oil and Natural Gas Corporation Limited explores for, develops, and produces crude oil and natural gas in India and internationally.
Established dividend payer and good value.