Key Insights

Harbour Energy's estimated fair value is UK£2.36 based on 2 Stage Free Cash Flow to Equity Current share price of UK£1.59 suggests Harbour Energy is potentially 33% undervalued Analyst price target for HBR is US$2.84, which is 20% above our fair value estimate

In this article we are going to estimate the intrinsic value of Harbour Energy plc (LON:HBR) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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The Method

We're using the 2-stage growth 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 a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF ($, Millions)  US$751.0m US$563.0m US$489.0m US$1.19b US$758.0m US$547.0m US$444.2m US$388.8m US$357.5m US$339.9m Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x2 Analyst x1 Analyst x1 Est @ -27.84% Est @ -18.80% Est @ -12.47% Est @ -8.04% Est @ -4.94% Present Value ($, Millions) Discounted @ 10%  US$680 US$461 US$363 US$798 US$460 US$301 US$221 US$175 US$146 US$125

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.7b

Story Continues

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.3%) 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 10%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$340m× (1 + 2.3%) ÷ (10%– 2.3%) = US$4.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.2b÷ ( 1 + 10%)10= US$1.6b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$5.3b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£1.6, the company appears quite undervalued at a 33% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.LSE:HBR Discounted Cash Flow April 19th 2025

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Harbour 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 10%, which is based on a levered beta of 1.596. 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.

See our latest analysis for Harbour Energy

SWOT Analysis for Harbour Energy

Strength

Debt is well covered by earnings and cashflows.

Dividend is in the top 25% of dividend payers in the market.

Weakness

Shareholders have been diluted in the past year.

Opportunity

Expected to breakeven next year.

Has sufficient cash runway for more than 3 years based on current free cash flows.

Good value based on P/S ratio and estimated fair value.

Threat

Dividends are not covered by cash flow.

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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 Harbour Energy, there are three fundamental factors you should explore:

Risks: You should be aware of the 2 warning signs for Harbour Energy we've uncovered before considering an investment in the company. Future Earnings: How does HBR'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the LSE every day. If you want to find the calculation for other stocks just search here.

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

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.

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