U.S. Markets closed
  • S&P Futures

    3,411.00
    -21.50 (-0.63%)
     
  • Dow Futures

    27,962.00
    -172.00 (-0.61%)
     
  • Nasdaq Futures

    11,623.75
    -67.50 (-0.58%)
     
  • Russell 2000 Futures

    1,594.00
    -9.10 (-0.57%)
     
  • Crude Oil

    39.80
    -0.23 (-0.57%)
     
  • Gold

    1,919.90
    -9.60 (-0.50%)
     
  • Silver

    24.98
    -0.27 (-1.05%)
     
  • EUR/USD

    1.1846
    -0.0021 (-0.1777%)
     
  • 10-Yr Bond

    0.8160
    +0.0190 (+2.38%)
     
  • Vix

    28.65
    -0.70 (-2.39%)
     
  • GBP/USD

    1.3131
    -0.0012 (-0.0945%)
     
  • USD/JPY

    104.6700
    +0.1100 (+0.1052%)
     
  • BTC-USD

    12,852.84
    +1,795.83 (+16.24%)
     
  • CMC Crypto 200

    257.52
    +12.63 (+5.16%)
     
  • FTSE 100

    5,776.50
    -112.72 (-1.91%)
     
  • Nikkei 225

    23,485.52
    -81.48 (-0.35%)
     

Are Investors Undervaluing Cimarex Energy Co. (NYSE:XEC) By 45%?

Simply Wall St
·6 mins read

In this article we are going to estimate the intrinsic value of Cimarex Energy Co. (NYSE:XEC) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Cimarex Energy

The model

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 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) forecast

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

Levered FCF ($, Millions)

US$336.6m

US$391.8m

US$432.8m

US$467.3m

US$496.5m

US$521.5m

US$543.4m

US$563.0m

US$580.9m

US$597.7m

Growth Rate Estimate Source

Analyst x6

Analyst x3

Est @ 10.44%

Est @ 7.98%

Est @ 6.25%

Est @ 5.04%

Est @ 4.19%

Est @ 3.6%

Est @ 3.19%

Est @ 2.9%

Present Value ($, Millions) Discounted @ 11%

US$303

US$318

US$316

US$307

US$294

US$278

US$261

US$243

US$226

US$209

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.8b

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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$598m× (1 + 2.2%) ÷ (11%– 2.2%) = US$6.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$6.9b÷ ( 1 + 11%)10= US$2.4b

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$5.2b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$28.3, the company appears quite undervalued at a 45% 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.

dcf
dcf

Important 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 Cimarex 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 11%, which is based on a levered beta of 1.472. 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.

Moving On:

Whilst important, the DCF calculation 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. 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. Why is the intrinsic value higher than the current share price? For Cimarex Energy, we've compiled three relevant items you should explore:

  1. Risks: Be aware that Cimarex Energy is showing 2 warning signs in our investment analysis , you should know about...

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

  3. 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.