Stock Analysis

Oil and Natural Gas Corporation Limited's (NSE:ONGC) Intrinsic Value Is Potentially 63% Above Its Share Price

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NSEI:ONGC
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How far off is Oil and Natural Gas Corporation Limited (NSE:ONGC) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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. 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

The calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF (₹, Millions) ₹336.0b ₹410.9b ₹388.5b ₹423.7b ₹459.1b ₹495.2b ₹532.5b ₹571.3b ₹612.0b ₹654.8b
Growth Rate Estimate Source Analyst x6 Analyst x7 Analyst x7 Est @ 9.05% Est @ 8.36% Est @ 7.87% Est @ 7.53% Est @ 7.29% Est @ 7.12% Est @ 7%
Present Value (₹, Millions) Discounted @ 17% ₹287.8k ₹301.6k ₹244.3k ₹228.2k ₹211.8k ₹195.8k ₹180.3k ₹165.7k ₹152.1k ₹139.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹2.1t

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 6.7%. We discount the terminal cash flows to today's value at a cost of equity of 17%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₹655b× (1 + 6.7%) ÷ (17%– 6.7%) = ₹7.0t

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹7.0t÷ ( 1 + 17%)10= ₹1.5t

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is ₹3.6t. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of ₹176, the company appears quite good value at a 38% 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.

dcf
NSEI:ONGC Discounted Cash Flow April 19th 2022

The 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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 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 17%, which is based on a levered beta of 1.558. 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.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Oil and Natural Gas, there are three essential elements you should explore:

  1. Risks: As an example, we've found 2 warning signs for Oil and Natural Gas that you need to consider before investing here.
  2. 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.
  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 Indian stock every day, so if you want to find the intrinsic value of any other stock just search here.

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