How far is Oceaneering International, Inc. (NYSE: OII) its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking expected future cash flows and discounting them to their present value. I will use the Discounted Cash Flow (DCF) model. Don’t be put off by the lingo, the math behind it is actually quite simple.
Remember, however, that there are many ways to estimate the value of a business and that a DCF is just a method. Anyone who wants to know a little more about intrinsic value should have a read on Simply Wall St analysis model.
See our latest analysis for Oceaneering International
The model
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is generally a period of higher growth which stabilizes towards the terminal value, captured in the second period of “regular growth”. First, we need to estimate the company’s cash flow over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage and that companies with free cash flow that will grow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in the early years than in the following years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of these future cash flows is then discounted to today’s value:
10-year Free Cash Flow (FCF) forecast
2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | |
Levered FCF ($, Millions) | US $ 61.6 million | US $ 84.8 million | US $ 71.0 million | US $ 76.0 million | US $ 78.5 million | US $ 80.8 million | US $ 82.8 million | US $ 84.7 million | US $ 86.5 million | US $ 88.2 million |
Source of estimated growth rate | Analyst x7 | Analyst x6 | Analyst x2 | Analyst x1 | East @ 3.33% | East @ 2.85% | East @ 2.52% | East @ 2.29% | Is @ 2.12% | East @ 2.01% |
Present value ($, millions) discounted at 9.8% | US $ 56.1 | US $ 70.3 | US $ 53.6 | US $ 52.2 | US $ 49.1 | US $ 46.0 | US $ 42.9 | US $ 40.0 | US $ 37.2 | US $ 34.5 |
(“East” = FCF growth rate estimated by Simply Wall St)
Present value of cash flow at 10 years (PVCF) = $ 481 million
The second step is also known as the terminal value; it is the cash flow of the business after the first step. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 10-year government bond rate (1.7%) to estimate future growth. In the same way as with the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 9.8%.
Terminal value (TV)= FCF_{2029} × (1 + g) ÷ (r – g) = US $ 88 million × (1 + 1.7%) ÷ 9.8% – 1.7%) = US $ 1.1 billion
Current value of the terminal value (PVTV)= TV / (1 + r)^{ten}= USD 1.1 billion ÷ (1 + 9.8%)^{ten}= US $ 434 million
The total value is the sum of the cash flows for the next ten years plus the final discounted value, which gives the total equity value, which in this case is US $ 915 million. The final step is to then divide the equity value by the number of shares outstanding. Compared to the current price of US $ 11.1, the company seems slightly overvalued at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – incoming garbage, outgoing garbage.
Important assumptions
We draw your attention to the fact that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of the investment is to develop your own assessment of the future performance of a business, so try the calculation yourself and test your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, it therefore does not give a complete picture of the potential performance of a company. Since we consider Oceaneering International 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 represents debt. In this calculation, we used 9.8%, which is based on a leveraged beta of 1.488. Beta is a measure of the volatility of a security compared to the market as a whole. We get our beta version of the average beta version of the globally comparable business sector, with a limit set between 0.8 and 2.0, which is a reasonable range for a stable business.
Next steps:
While evaluating a business is important, it should not be the only measure you consider when looking for a business. The DCF model is not a perfect tool for evaluating actions. Rather, it should be viewed as a guide to “what assumptions must be true for this stock to be undervalued / overvalued?” If a business grows at a different rate, or if its cost of equity or risk-free rate changes significantly, production can be very different. What is the reason why the share price differs from the intrinsic value? For Oceaneering International, I have gathered three fundamental factors that you should consider:
Financial health: Does the OII have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
Future earnings: How does OII’s growth rate compare to its peers and to the overall market? Deepen the number of analyst consensus for the coming years by interacting with our free graph of analysts growth forecasts.
Other high quality alternatives: Are there other high quality stocks you could own instead of OII? To explore our interactive list of high quality stocks to get an idea of what else you might miss!
PS. Simply Wall St updates its DCF calculation for each US stock every day, so if you want to find the intrinsic value of any other stock just search here.
If you spot an error that merits correction, please contact the publisher at [email protected] This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell securities and does not take into account your objectives or your financial situation. Simply Wall St has no position in the stocks mentioned.
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