Does the April share price for Public Joint Stock Company Gazprom (MCX:GAZP) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected 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. There's really not all that much to it, even though it might appear quite complex.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
What's the estimated valuation?
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. 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, 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 (RUB, Millions)||₽224.4b||₽469.2b||₽607.5b||₽853.9b||₽1.07t||₽1.26t||₽1.43t||₽1.61t||₽1.78t||₽1.96t|
|Growth Rate Estimate Source||Analyst x7||Analyst x6||Analyst x5||Analyst x3||Analyst x3||Est @ 16.98%||Est @ 14.19%||Est @ 12.24%||Est @ 10.88%||Est @ 9.92%|
|Present Value (RUB, Millions) Discounted @ 24%||₽181.3k||₽306.4k||₽320.6k||₽364.2k||₽369.9k||₽349.7k||₽322.7k||₽292.7k||₽262.2k||₽232.9k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₽3.0t
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 7.7%. We discount the terminal cash flows to today's value at a cost of equity of 24%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = ₽2.0t× (1 + 7.7%) ÷ (24%– 7.7%) = ₽13t
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₽13t÷ ( 1 + 24%)10= ₽1.6t
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₽4.6t. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₽225, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Gazprom 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 24%, which is based on a levered beta of 1.898. 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.
Whilst important, the DCF calculation 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. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Gazprom, we've compiled three essential aspects you should consider:
- Risks: Every company has them, and we've spotted 2 warning signs for Gazprom you should know about.
- Future Earnings: How does GAZP'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 Russian stock every day, so if you want to find the intrinsic value of any other stock just search here.
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Public Joint Stock Company Gazprom, an integrated energy company, engages in the geological exploration, production, processing, storage, transportation, and sale of gas, gas condensates, and oil in Russia and internationally.
Excellent balance sheet with solid track record and pays a dividend.