Stock Analysis

Is There An Opportunity With Cheniere Energy, Inc.'s (NYSEMKT:LNG) 47% Undervaluation?

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NYSEAM:LNG
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Today we will run through one way of estimating the intrinsic value of Cheniere Energy, Inc. (NYSEMKT:LNG) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Cheniere Energy

Step by step through the calculation

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 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, 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

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) US$1.43b US$2.06b US$2.90b US$3.36b US$3.69b US$3.98b US$4.22b US$4.42b US$4.60b US$4.77b
Growth Rate Estimate Source Analyst x4 Analyst x2 Analyst x2 Analyst x2 Est @ 10.01% Est @ 7.67% Est @ 6.04% Est @ 4.89% Est @ 4.09% Est @ 3.53%
Present Value ($, Millions) Discounted @ 14% US$1.3k US$1.6k US$1.9k US$2.0k US$1.9k US$1.8k US$1.7k US$1.5k US$1.4k US$1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$16b

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 (2.2%) 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 14%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$4.8b× (1 + 2.2%) ÷ (14%– 2.2%) = US$41b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$41b÷ ( 1 + 14%)10= US$11b

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$27b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$56.8, the company appears quite undervalued at a 47% 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.

dcf
AMEX:LNG Discounted Cash Flow December 2nd 2020

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Cheniere Energy 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 14%, which is based on a levered beta of 2.000. 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 ideally won't be the sole piece of analysis you scrutinize 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. 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 higher than the current share price? For Cheniere Energy, we've compiled three pertinent aspects you should explore:

  1. Risks: Case in point, we've spotted 2 warning signs for Cheniere Energy you should be aware of, and 1 of them doesn't sit too well with us.
  2. Future Earnings: How does LNG'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. 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.

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