A Look At The Intrinsic Value Of Shelf Drilling (North Sea), Ltd. (OB:SDNS)

Key Insights

• The projected fair value for Shelf Drilling (North Sea) is kr25.97 based on 2 Stage Free Cash Flow to Equity
• With kr25.00 share price, Shelf Drilling (North Sea) appears to be trading close to its estimated fair value
• Peers of Shelf Drilling (North Sea) are currently trading on average at a 30% premium

Today we will run through one way of estimating the intrinsic value of Shelf Drilling (North Sea), Ltd. (OB:SDNS) by estimating the company's future cash flows and discounting them to their present 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.

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 Shelf Drilling (North Sea)

Is Shelf Drilling (North Sea) Fairly Valued?

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (NOK, Millions)	-kr10.3m	kr21.4m	kr39.9m	kr64.1m	kr91.6m	kr119.5m	kr145.4m	kr168.1m	kr187.1m	kr202.8m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 86.09%	Est @ 60.67%	Est @ 42.88%	Est @ 30.43%	Est @ 21.71%	Est @ 15.61%	Est @ 11.34%	Est @ 8.35%
Present Value (NOK, Millions) Discounted @ 6.8%	-kr9.6	kr18.8	kr32.7	kr49.3	kr65.9	kr80.5	kr91.7	kr99.3	kr104	kr105

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr637m

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 1.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = kr203m× (1 + 1.4%) ÷ (6.8%– 1.4%) = kr3.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= kr3.8b÷ ( 1 + 6.8%)¹⁰= kr2.0b

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 kr2.6b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of kr25.0, the company appears about fair value at a 3.7% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Shelf Drilling (North Sea) 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 0.800. 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.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Shelf Drilling (North Sea), we've put together three pertinent factors you should look at:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Shelf Drilling (North Sea) , and understanding this should be part of your investment process.
2. Future Earnings: How does SDNS'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 Norwegian stock every day, so if you want to find the intrinsic value of any other stock just search here.

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.