How far off is NRG Energy, Inc. (NYSE:NRG) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by estimating the company’s future cash flows and discounting them to their present value. This is done using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! 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 and its not January 2019 then I highly recommend you check out the latest calculation for NRG Energy by following the link below.
Step by step through the calculation
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow forecast
|Levered FCF ($, Millions)||$2.16k||$1.31k||$1.27k||$1.19k||$1.12k|
|Source||Analyst x2||Analyst x3||Analyst x1||Est @ -5.96%||Est @ -5.96%|
|Present Value Discounted @ 8.59%||$1.99k||$1.11k||$990.26||$857.54||$742.61|
Present Value of 5-year Cash Flow (PVCF)= US$5.7b
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.6%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$1.1b × (1 + 2.9%) ÷ (8.6% – 2.9%) = US$20b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$20b ÷ ( 1 + 8.6%)5 = US$14b
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$19b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $66.39. Relative to the current share price of $39.55, the stock is quite good value at a 40% discount to what it is available for right now.
I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at NRG Energy as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.6%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
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 NRG, I’ve put together three pertinent factors you should look at:
- Financial Health: Does NRG have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does NRG’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: Are there other high quality stocks you could be holding instead of NRG? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
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The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.