W&T Offshore, Inc. (NYSE:WTI) Shares Could Be 31% Above Their Intrinsic Value Estimate

Key Insights

• W&T Offshore's estimated fair value is US$2.26 based on 2 Stage Free Cash Flow to Equity
• W&T Offshore is estimated to be 31% overvalued based on current share price of US$2.96
• Our fair value estimate is 76% lower than W&T Offshore's analyst price target of US$9.55

Today we will run through one way of estimating the intrinsic value of W&T Offshore, Inc. (NYSE:WTI) by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for W&T Offshore

Crunching The Numbers

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. 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.

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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$22.5m	US$29.0m	US$29.3m	US$29.7m	US$30.2m	US$30.7m	US$31.3m	US$31.9m	US$32.6m	US$33.3m
Growth Rate Estimate Source	Analyst x2	Analyst x1	Est @ 1.00%	Est @ 1.36%	Est @ 1.62%	Est @ 1.80%	Est @ 1.93%	Est @ 2.01%	Est @ 2.08%	Est @ 2.12%
Present Value ($, Millions) Discounted @ 10%	US$20.4	US$23.8	US$21.8	US$20.0	US$18.4	US$17.0	US$15.7	US$14.5	US$13.4	US$12.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$177m

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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$33m× (1 + 2.2%) ÷ (10%– 2.2%) = US$416m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$416m÷ ( 1 + 10%)¹⁰= US$155m

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$332m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$3.0, the company appears reasonably expensive at the time of writing. 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.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 W&T Offshore 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 10%, which is based on a levered beta of 1.636. 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 W&T Offshore

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value lower than the current share price? For W&T Offshore, we've put together three fundamental factors you should consider:

1. Risks: You should be aware of the 5 warning signs for W&T Offshore (2 are significant!) we've uncovered before considering an investment in the company.
2. Future Earnings: How does WTI'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 NYSE every day. If you want to find the calculation for other stocks just search here.

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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.