Peyto Exploration & Development Corp. (TSE:PEY) Shares Could Be 30% Below Their Intrinsic Value Estimate
Key Insights
Peyto Exploration & Development's estimated fair value is CA$17.96 based on Dividend Discount Model
Peyto Exploration & Development is estimated to be 30% undervalued based on current share price of CA$12.56
When compared to theindustry average discount to fair value of 17%, Peyto Exploration & Development's competitors seem to be trading at a lesser discount
How far off is Peyto Exploration & Development Corp. (TSE:PEY) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced 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.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
See our latest analysis for Peyto Exploration & Development
Is Peyto Exploration & Development Fairly Valued?
We have to calculate the value of Peyto Exploration & Development slightly differently to other stocks because it is a oil and gas company. Instead of using free cash flows, which are hard to estimate and often not reported by analysts in this industry, dividends per share (DPS) payments are used. Unless a company pays out the majority of its FCF as a dividend, this method will typically underestimate the value of the stock. We use the Gordon Growth Model, which assumes dividend will grow into perpetuity at a rate that can be sustained. For a number of reasons a very conservative growth rate is used that cannot exceed that of a company's Gross Domestic Product (GDP). In this case we used the 5-year average of the 10-year government bond yield (1.9%). The expected dividend per share is then discounted to today's value at a cost of equity of 9.1%. Compared to the current share price of CA$12.6, the company appears quite undervalued at a 30% 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.
Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)
= CA$1.3 / (9.1% – 1.9%)
= CA$18.0
Important Assumptions
Now 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 Peyto Exploration & Development 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 9.1%, which is based on a levered beta of 1.453. 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 Peyto Exploration & Development
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Dividends are covered by earnings and cash flows.
Dividend is in the top 25% of dividend payers in the market.
Weakness
Earnings growth over the past year is below its 5-year average.
Shareholders have been diluted in the past year.
Opportunity
Annual revenue is forecast to grow faster than the Canadian market.
Trading below our estimate of fair value by more than 20%.
Significant insider buying over the past 3 months.
Threat
No apparent threats visible for PEY.
Moving On:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. What is the reason for the share price sitting below the intrinsic value? For Peyto Exploration & Development, we've put together three important factors you should further examine:
Risks: Case in point, we've spotted 2 warning signs for Peyto Exploration & Development you should be aware of.
Future Earnings: How does PEY'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 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. Simply Wall St updates its DCF calculation for every Canadian 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.
