Estimating The Fair Value Of Oceaneering International, Inc. (NYSE:OII)
Today we will run through one way of estimating the intrinsic value of Oceaneering International, Inc. (NYSE:OII) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
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.
Check out our latest analysis for Oceaneering International
Crunching the numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, 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
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF ($, Millions) | US$91.5m | US$52.5m | US$54.0m | US$62.0m | US$94.0m | US$107.9m | US$119.6m | US$129.5m | US$137.8m | US$144.8m |
Growth Rate Estimate Source | Analyst x4 | Analyst x4 | Analyst x1 | Analyst x1 | Analyst x1 | Est @ 14.74% | Est @ 10.93% | Est @ 8.26% | Est @ 6.4% | Est @ 5.09% |
Present Value ($, Millions) Discounted @ 13% | US$81.3 | US$41.5 | US$37.9 | US$38.7 | US$52.2 | US$53.2 | US$52.5 | US$50.5 | US$47.7 | US$44.6 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$500m
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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 13%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$145m× (1 + 2.0%) ÷ (13%– 2.0%) = US$1.4b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.4b÷ ( 1 + 13%)10= US$435m
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$935m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$9.3, the company appears about fair value at a 1.7% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
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. 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 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 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.
Looking Ahead:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. 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 Oceaneering International, we've compiled three important factors you should assess:
Risks: As an example, we've found 3 warning signs for Oceaneering International (1 is a bit concerning!) that you need to consider before investing here.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for OII's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.
This article by Simply Wall St is general in nature. 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.
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