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Calculating The Intrinsic Value Of NRG Energy Inc (NYSE:NRG)

How far off is NRG Energy Inc (NYSE:NRG) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today’s value. I will use the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in November 2018 so be sure check out the updated calculation by following the link below.

The method

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow estimate

 2019 2020 2021 2022 2023 Levered FCF (\$, Millions) \$1.25k \$1.38k \$1.20k \$1.15k \$1.11k Source Analyst x2 Analyst x3 Analyst x1 Est @ -3.76% Est @ -3.76% Present Value Discounted @ 10.57% \$1.13k \$1.13k \$884.02 \$769.45 \$669.73

Present Value of 5-year Cash Flow (PVCF)= US\$4.6b

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 10.6%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US\$1.1b × (1 + 2.9%) ÷ (10.6% – 2.9%) = US\$15.0b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US\$15.0b ÷ ( 1 + 10.6%)5 = US\$9.0b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US\$13.6b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of \$45.06. Relative to the current share price of \$37.95, the stock is about right, perhaps slightly undervalued at a 16% discount to what it is available for right now. NYSE:NRG Intrinsic Value Export November 8th 18

The assumptions

I’d like to 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at NRG Energy as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 10.6%, which is based on a levered beta of 1.081. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. For NRG, I’ve put together three relevant aspects you should look at:

1. Financial Health: Does NRG have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does NRG’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: Are there other high quality stocks you could be holding instead of NRG? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com. 