Halliburton Company (NYSE:HAL) Shares Could Be 23% Below Their Intrinsic Value Estimate
Today we will run through one way of estimating the intrinsic value of Halliburton Company (NYSE:HAL) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
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.
View our latest analysis for Halliburton
Is Halliburton fairly valued?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Levered FCF ($, Millions) | US$1.39b | US$2.08b | US$2.51b | US$3.04b | US$3.32b | US$3.52b | US$3.70b | US$3.85b | US$3.98b | US$4.10b |
Growth Rate Estimate Source | Analyst x11 | Analyst x10 | Analyst x3 | Analyst x1 | Analyst x1 | Est @ 6.23% | Est @ 4.94% | Est @ 4.03% | Est @ 3.4% | Est @ 2.96% |
Present Value ($, Millions) Discounted @ 9.3% | US$1.3k | US$1.7k | US$1.9k | US$2.1k | US$2.1k | US$2.1k | US$2.0k | US$1.9k | US$1.8k | US$1.7k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$19b
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. 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 (1.9%) 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 9.3%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$4.1b× (1 + 1.9%) ÷ (9.3%– 1.9%) = US$57b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$57b÷ ( 1 + 9.3%)10= US$23b
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$42b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$36.0, the company appears a touch undervalued at a 23% 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.
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 Halliburton 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 9.3%, which is based on a levered beta of 1.733. 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:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Halliburton, we've compiled three relevant items you should further research:
Risks: To that end, you should be aware of the 1 warning sign we've spotted with Halliburton .
Future Earnings: How does HAL'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.
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.
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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.
