A Look At The Intrinsic Value Of North European Oil Royalty Trust (NYSE:NRT)

Key Insights

• North European Oil Royalty Trust's estimated fair value is US$6.74 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$5.97 suggests North European Oil Royalty Trust is potentially trading close to its fair value
• When compared to theindustry average discount to fair value of 21%, North European Oil Royalty Trust's competitors seem to be trading at a greater discount

In this article we are going to estimate the intrinsic value of North European Oil Royalty Trust (NYSE:NRT) by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for North European Oil Royalty Trust

Is North European Oil Royalty Trust 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 begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$7.53m	US$5.42m	US$4.39m	US$3.84m	US$3.53m	US$3.35m	US$3.26m	US$3.21m	US$3.21m	US$3.23m
Growth Rate Estimate Source	Est @ -41.08%	Est @ -28.07%	Est @ -18.96%	Est @ -12.59%	Est @ -8.12%	Est @ -5.00%	Est @ -2.81%	Est @ -1.28%	Est @ -0.21%	Est @ 0.54%
Present Value ($, Millions) Discounted @ 7.4%	US$7.0	US$4.7	US$3.5	US$2.9	US$2.5	US$2.2	US$2.0	US$1.8	US$1.7	US$1.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$30m

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 (2.3%) 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 7.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$3.2m× (1 + 2.3%) ÷ (7.4%– 2.3%) = US$65m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$65m÷ ( 1 + 7.4%)¹⁰= US$32m

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$62m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$6.0, the company appears about fair value at a 11% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 North European Oil Royalty Trust 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 7.4%, which is based on a levered beta of 1.101. 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.

SWOT Analysis for North European Oil Royalty Trust

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. 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 North European Oil Royalty Trust, we've put together three fundamental aspects you should explore:

1. Risks: Take risks, for example - North European Oil Royalty Trust has 2 warning signs we think you should be aware of.
2. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

PS. Simply Wall St updates its DCF calculation for every American 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.