How far off is Public Joint Stock Company Gazprom (MCX:GAZP) 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 expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.
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.
Generally we assume that a dollar today is more valuable than a dollar in the future, 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
|Levered FCF (RUB, Millions)||₽1.06t||₽1.01t||₽990.5b||₽1.00t||₽1.01t||₽1.04t||₽1.08t||₽1.14t||₽1.20t||₽1.28t|
|Growth Rate Estimate Source||Analyst x6||Analyst x6||Analyst x5||Analyst x3||Est @ 0.85%||Est @ 2.79%||Est @ 4.15%||Est @ 5.1%||Est @ 5.77%||Est @ 6.23%|
|Present Value (RUB, Millions) Discounted @ 18%||₽901.0k||₽729.7k||₽607.0k||₽521.9k||₽447.1k||₽390.4k||₽345.4k||₽308.3k||₽277.0k||₽249.9k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₽4.8t
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. 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 (7.3%) 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 18%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₽1.3t× (1 + 7.3%) ÷ (18%– 7.3%) = ₽13t
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₽13t÷ ( 1 + 18%)10= ₽2.6t
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₽7.4t. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₽352, the company appears around fair value at the time of writing. 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.
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 18%, which is based on a levered beta of 1.671. 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 shouldn't be the only metric you look at when researching 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Gazprom, there are three pertinent aspects you should further research:
- Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Gazprom (at least 1 which is potentially serious) , and understanding them should be part of your investment process.
- 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.
Valuation is complex, but we're helping make it simple.
Find out whether Gazprom 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
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.
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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.