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# Estimating The Intrinsic Value Of Beach Energy Limited (ASX:BPT)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Beach Energy Limited (ASX:BPT) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. This is done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Beach Energy

### The calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, and so 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 (A\$, Millions) AU\$27.0m AU\$435.0m AU\$411.3m AU\$397.0m AU\$388.6m AU\$384.1m AU\$382.2m AU\$382.1m AU\$383.3m AU\$385.4m Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ -5.45% Est @ -3.49% Est @ -2.12% Est @ -1.16% Est @ -0.49% Est @ -0.02% Est @ 0.31% Est @ 0.54% Present Value (A\$, Millions) Discounted @ 6.3% AU\$25.4 AU\$385 AU\$343 AU\$311 AU\$287 AU\$266 AU\$249 AU\$235 AU\$222 AU\$210

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU\$2.5b

After calculating the present value of future cash flows in the intial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 1.1%. We discount the terminal cash flows to today's value at a cost of equity of 6.3%.

Terminal Value (TV)= FCF2029 Ã— (1 + g) Ã· (r â€“ g) = AU\$385mÃ— (1 + 1.1%) Ã· 6.3%â€“ 1.1%) = AU\$7.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU\$7.5bÃ· ( 1 + 6.3%)10= AU\$4.1b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU\$6.6b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU\$2.6, the company appears about fair value at a 12% 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.

### The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Beach 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 6.3%, which is based on a levered beta of 0.956. 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.

### Next Steps:

Although the valuation of a company is important, it shouldnâ€™t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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 Beach Energy, I've compiled three essential aspects you should look at:

1. Future Earnings: How does BPT'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.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for BPT's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of BPT? 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 ASX every day. If you want to find the calculation for other stocks just search here.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.