An Intrinsic Value Calculation For Ecopetrol SA (EC) Shows It’s 26.30% Undervalued
I am going to run you through how I calculated the intrinsic value of Ecopetrol SA (NYSE:EC) using the discounted cash flow (DCF) method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this after December 2017 then I highly recommend you check out the latest calculation for Ecopetrol here.
Is EC fairly valued?
I use what is known as the 2-stage 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 perpetual stable growth rate. Firstly, I took the analyst consensus forecast of EC’s levered free cash flow (FCF) over the next five years and discounted these values at the cost of equity of 10.1%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of COP34,605,012.0M. Want to know how I calculated this value? Read our detailed analysis here.
The infographic above illustrates how EC’s top and bottom lines are expected to move in the future, which should give you an idea of EC’s outlook. Now we need to determine the terminal value, which is the business’s cash flow after the first stage. It’s appropriate to use the 10-year government bond rate of 2.8% as the stable growth rate, which is rightly below GDP growth, but more towards the conservative side. The present value of the terminal value after discounting it back five years is COP64,425,578.5M.
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is COP99,030,590.5M. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value of COP16.13, which, compared to the current share price of COP11.89, we find that Ecopetrol is about right, perhaps slightly undervalued at a 26.30% discount to what it is available for right now.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For EC, I’ve compiled three important aspects you should further examine:
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the NYSE every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
