Today we will run through one way of estimating the intrinsic value of PJSC LUKOIL (MCX:LKOH) by projecting its future cash flows and then discounting them to today's value. I will be using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.
Check out our latest analysis for PJSC LUKOIL
What's the estimated valuation?
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. 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, 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) estimate
| 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | |
| Levered FCF (RUB, Millions) | ₽271.5b | ₽417.5b | ₽516.7b | ₽650.8b | ₽585.5b | ₽560.3b | ₽557.3b | ₽569.1b | ₽591.7b | ₽622.8b |
| Growth Rate Estimate Source | Analyst x7 | Analyst x9 | Analyst x6 | Analyst x4 | Analyst x3 | Est @ -4.3% | Est @ -0.53% | Est @ 2.11% | Est @ 3.96% | Est @ 5.26% |
| Present Value (RUB, Millions) Discounted @ 20% | ₽226.3k | ₽290.2k | ₽299.4k | ₽314.4k | ₽235.8k | ₽188.1k | ₽156.0k | ₽132.8k | ₽115.1k | ₽101.0k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₽2.1t
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 10-year government bond rate of 8.3%. We discount the terminal cash flows to today's value at a cost of equity of 20%.
Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = ₽623b× (1 + 8.3%) ÷ 20%– 8.3%) = ₽5.8t
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₽5.8t÷ ( 1 + 20%)10= ₽937b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₽3.0t. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of ₽4.9k, 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 assumptions
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 PJSC LUKOIL 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 20%, which is based on a levered beta of 1.162. 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.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For PJSC LUKOIL, There are three additional aspects you should look at:
- Risks: Every company has them, and we've spotted 2 warning signs for PJSC LUKOIL you should know about.
- Future Earnings: How does LKOH'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 RU stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.