A Look At The Fair Value Of CGX Energy Inc. (CVE:OYL)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, CGX Energy fair value estimate is CA$1.04

• With CA$1.14 share price, CGX Energy appears to be trading close to its estimated fair value

• Peers of CGX Energy are currently trading on average at a 21% discount

In this article we are going to estimate the intrinsic value of CGX Energy Inc. (CVE:OYL) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

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.

See our latest analysis for CGX Energy

Crunching The Numbers

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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$10.3m	US$12.0m	US$13.4m	US$14.6m	US$15.6m	US$16.4m	US$17.1m	US$17.7m	US$18.2m	US$18.7m
Growth Rate Estimate Source	Est @ 22.13%	Est @ 16.05%	Est @ 11.79%	Est @ 8.81%	Est @ 6.73%	Est @ 5.27%	Est @ 4.25%	Est @ 3.53%	Est @ 3.03%	Est @ 2.68%
Present Value ($, Millions) Discounted @ 7.6%	US$9.6	US$10.4	US$10.8	US$10.9	US$10.8	US$10.6	US$10.2	US$9.9	US$9.4	US$9.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$102m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.6%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$19m× (1 + 1.9%) ÷ (7.6%– 1.9%) = US$333m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$333m÷ ( 1 + 7.6%)¹⁰= US$160m

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$262m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$1.1, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

The 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. 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 CGX Energy 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 7.6%, which is based on a levered beta of 1.146. 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 CGX Energy

Strength

• Currently debt free.

Weakness

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

Opportunity

• Has sufficient cash runway for more than 3 years based on current free cash flows.

• Lack of analyst coverage makes it difficult to determine OYL's earnings prospects.

Threat

• No apparent threats visible for OYL.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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. 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. For CGX Energy, we've compiled three relevant elements you should explore:

1. Risks: You should be aware of the 2 warning signs for CGX Energy we've uncovered before considering an investment in the company.

2. 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!

3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSXV 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.