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Estimating The Intrinsic Value Of Schlumberger Limited (NYSE:SLB)

Key Insights

  • Schlumberger's estimated fair value is US$65.34 based on 2 Stage Free Cash Flow to Equity

  • Schlumberger's US$52.72 share price indicates it is trading at similar levels as its fair value estimate

  • The US$68.70 analyst price target for SLB is 5.1% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Schlumberger Limited (NYSE:SLB) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Schlumberger

What's The Estimated Valuation?

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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$4.51b

US$5.64b

US$6.51b

US$7.16b

US$7.65b

US$8.06b

US$8.43b

US$8.75b

US$9.04b

US$9.31b

Growth Rate Estimate Source

Analyst x15

Analyst x10

Analyst x2

Analyst x2

Est @ 6.83%

Est @ 5.45%

Est @ 4.48%

Est @ 3.80%

Est @ 3.33%

Est @ 2.99%

Present Value ($, Millions) Discounted @ 9.8%

US$4.1k

US$4.7k

US$4.9k

US$4.9k

US$4.8k

US$4.6k

US$4.4k

US$4.1k

US$3.9k

US$3.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$44b

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. 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 9.8%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$9.3b× (1 + 2.2%) ÷ (9.8%– 2.2%) = US$125b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$125b÷ ( 1 + 9.8%)10= US$49b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$93b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$52.7, the company appears about fair value at a 19% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
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. 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 Schlumberger 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 9.8%, which is based on a levered beta of 1.517. 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 Schlumberger

Strength

  • Earnings growth over the past year exceeded its 5-year average.

  • Debt is well covered by earnings and cashflows.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Earnings growth over the past year underperformed the Energy Services industry.

  • Dividend is low compared to the top 25% of dividend payers in the Energy Services market.

Opportunity

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

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

Threat

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

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Schlumberger, there are three relevant factors you should assess:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Schlumberger , and understanding these should be part of your investment process.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SLB's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  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. 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.

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.

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