Advertisement
Canada markets open in 2 hours 54 minutes
  • S&P/TSX

    22,872.65
    +182.26 (+0.80%)
     
  • S&P 500

    5,564.41
    +59.41 (+1.08%)
     
  • DOW

    40,415.44
    +127.91 (+0.32%)
     
  • CAD/USD

    0.7265
    -0.0005 (-0.07%)
     
  • CRUDE OIL

    79.95
    +0.17 (+0.21%)
     
  • Bitcoin CAD

    92,189.28
    -626.73 (-0.68%)
     
  • CMC Crypto 200

    1,383.00
    -2.25 (-0.16%)
     
  • GOLD FUTURES

    2,407.20
    +12.50 (+0.52%)
     
  • RUSSELL 2000

    2,220.65
    +36.30 (+1.66%)
     
  • 10-Yr Bond

    4.2600
    +0.0210 (+0.50%)
     
  • NASDAQ futures

    19,975.50
    -25.50 (-0.13%)
     
  • VOLATILITY

    15.00
    +0.09 (+0.60%)
     
  • FTSE

    8,217.75
    +18.97 (+0.23%)
     
  • NIKKEI 225

    39,594.39
    -4.61 (-0.01%)
     
  • CAD/EUR

    0.6688
    +0.0016 (+0.24%)
     

Estimating The Fair Value Of Hess Corporation (NYSE:HES)

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Hess fair value estimate is US$159

  • Hess' US$137 share price indicates it is trading at similar levels as its fair value estimate

  • The US$159 analyst price target for HESis comparable to our estimate of fair value.

Today we will run through one way of estimating the intrinsic value of Hess Corporation (NYSE:HES) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. 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 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.

ADVERTISEMENT

See our latest analysis for Hess

Step By Step Through The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

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

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$1.68b

US$1.62b

US$2.64b

US$2.77b

US$3.43b

US$3.93b

US$4.35b

US$4.71b

US$5.01b

US$5.26b

Growth Rate Estimate Source

Analyst x1

Analyst x3

Analyst x3

Analyst x3

Analyst x2

Est @ 14.47%

Est @ 10.76%

Est @ 8.17%

Est @ 6.35%

Est @ 5.08%

Present Value ($, Millions) Discounted @ 9.6%

US$1.5k

US$1.3k

US$2.0k

US$1.9k

US$2.2k

US$2.3k

US$2.3k

US$2.3k

US$2.2k

US$2.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$20b

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 (2.1%) 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 9.6%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$5.3b× (1 + 2.1%) ÷ (9.6%– 2.1%) = US$72b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$72b÷ ( 1 + 9.6%)10= US$29b

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$49b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$137, the company appears about fair value at a 14% discount to where the stock price trades currently. 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.

dcf
dcf

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Hess 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 9.6%, which is based on a levered beta of 1.263. 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 Hess

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is well covered by earnings and cashflows.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Dividend is low compared to the top 25% of dividend payers in the Oil and Gas market.

Opportunity

  • Annual earnings are forecast to grow faster than the American market.

  • Current share price is below our estimate of fair value.

Threat

  • Annual revenue is forecast to grow slower than the American market.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. For Hess, we've put together three further factors you should further research:

  1. Risks: For example, we've discovered 2 warning signs for Hess that you should be aware of before investing here.

  2. Future Earnings: How does HES'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here