Stock Analysis

Subsea 7 S.A.'s (OB:SUBC) Intrinsic Value Is Potentially 97% Above Its Share Price

  •  Updated
OB:SUBC
Source: Shutterstock

Today we will run through one way of estimating the intrinsic value of Subsea 7 S.A. (OB:SUBC) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. 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.

Check out our latest analysis for Subsea 7

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.

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) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$194.3m US$386.8m US$401.7m US$379.0m US$366.0m US$358.5m US$354.5m US$352.8m US$352.9m US$354.0m
Growth Rate Estimate Source Analyst x7 Analyst x7 Analyst x2 Analyst x1 Est @ -3.42% Est @ -2.07% Est @ -1.12% Est @ -0.46% Est @ 0.01% Est @ 0.33%
Present Value ($, Millions) Discounted @ 7.5% US$181 US$335 US$323 US$284 US$255 US$232 US$213 US$198 US$184 US$172

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.4b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$354m× (1 + 1.1%) ÷ (7.5%– 1.1%) = US$5.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$5.6b÷ ( 1 + 7.5%)10= US$2.7b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$5.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of kr88.6, the company appears quite good value at a 49% 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.

dcf
OB:SUBC Discounted Cash Flow September 6th 2022

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 Subsea 7 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 7.5%, which is based on a levered beta of 1.515. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Subsea 7, we've put together three additional aspects you should assess:

  1. Financial Health: Does SUBC have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does SUBC'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the OB every day. If you want to find the calculation for other stocks just search here.

Valuation is complex, but we're helping make it simple.

Find out whether Subsea 7 is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

About OB:SUBC

Subsea 7

Subsea 7 S.A. delivers offshore projects and services for the evolving energy industry worldwide.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation0
Future Growth4
Past Performance3
Financial Health6
Dividends0

Read more about these checks in the individual report sections or in our analysis model.

Flawless balance sheet with reasonable growth potential.