Petrofac Limited (LON:PFC) Shares Could Be 39% Below Their Intrinsic Value Estimate
Key Insights
Petrofac's estimated fair value is UK£1.22 based on 2 Stage Free Cash Flow to Equity
Current share price of UK£0.75 suggests Petrofac is potentially 39% undervalued
Analyst price target for PFC is US$0.88 which is 28% below our fair value estimate
Today we will run through one way of estimating the intrinsic value of Petrofac Limited (LON:PFC) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for Petrofac
The Calculation
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$117.0m | US$71.0m | US$87.0m | US$92.5m | US$96.9m | US$100.6m | US$103.7m | US$106.4m | US$108.7m | US$110.8m |
Growth Rate Estimate Source | Analyst x2 | Analyst x3 | Analyst x1 | Est @ 6.30% | Est @ 4.83% | Est @ 3.79% | Est @ 3.07% | Est @ 2.56% | Est @ 2.21% | Est @ 1.96% |
Present Value ($, Millions) Discounted @ 13% | US$103 | US$55.4 | US$60.0 | US$56.3 | US$52.2 | US$47.8 | US$43.5 | US$39.4 | US$35.6 | US$32.1 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$526m
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. 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 1.4%. We discount the terminal cash flows to today's value at a cost of equity of 13%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$111m× (1 + 1.4%) ÷ (13%– 1.4%) = US$951m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$951m÷ ( 1 + 13%)10= US$275m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$801m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£0.7, the company appears quite undervalued at a 39% discount to where the stock price trades currently. 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.
Important Assumptions
Now 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 Petrofac 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 13%, 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.
SWOT Analysis for Petrofac
Strength
Debt is well covered by earnings.
Weakness
No major weaknesses identified for PFC.
Opportunity
Forecast to reduce losses next year.
Has sufficient cash runway for more than 3 years based on current free cash flows.
Good value based on P/S ratio and estimated fair value.
Threat
Debt is not well covered by operating cash flow.
Total liabilities exceed total assets, which raises the risk of financial distress.
Looking Ahead:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. Why is the intrinsic value higher than the current share price? For Petrofac, there are three pertinent factors you should assess:
Risks: Be aware that Petrofac is showing 2 warning signs in our investment analysis , you should know about...
Future Earnings: How does PFC'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 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 British 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. 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.