An Intrinsic Calculation For W&T Offshore, Inc. (NYSE:WTI) Suggests It's 36% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, W&T Offshore fair value estimate is US$3.76

• W&T Offshore's US$2.41 share price signals that it might be 36% undervalued

• Analyst price target for WTI is US$8.75, which is 133% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of W&T Offshore, Inc. (NYSE:WTI) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for W&T Offshore

The Model

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$15.0m	US$35.0m	US$54.0m	US$54.4m	US$55.1m	US$55.9m	US$56.9m	US$58.0m	US$59.2m	US$60.4m
Growth Rate Estimate Source	Analyst x2	Analyst x1	Analyst x1	Est @ 0.74%	Est @ 1.21%	Est @ 1.53%	Est @ 1.76%	Est @ 1.92%	Est @ 2.03%	Est @ 2.11%
Present Value ($, Millions) Discounted @ 11%	US$13.6	US$28.6	US$39.9	US$36.3	US$33.2	US$30.5	US$28.0	US$25.8	US$23.8	US$22.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$282m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.3%) 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 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$60m× (1 + 2.3%) ÷ (11%– 2.3%) = US$741m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$741m÷ ( 1 + 11%)¹⁰= US$270m

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$552m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$2.4, the company appears quite undervalued at a 36% 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

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 W&T Offshore 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 11%, which is based on a levered beta of 1.813. 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 W&T Offshore

Strength

• Debt is well covered by cash flow.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings declined over the past year.

• Interest payments on debt are not well covered.

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

Opportunity

• Trading below our estimate of fair value by more than 20%.

Threat

• Annual earnings are forecast to decline for the next 3 years.

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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 W&T Offshore, we've put together three fundamental items you should further examine:

1. Risks: For example, we've discovered 4 warning signs for W&T Offshore (2 are significant!) that you should be aware of before investing here.

2. Future Earnings: How does WTI'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.

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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.