Key Insights

The projected fair value for Genesis Energy is NZ$1.79 based on 2 Stage Free Cash Flow to Equity Current share price of NZ$2.14 suggests Genesis Energy is potentially trading close to its fair value Our fair value estimate is 30% lower than Genesis Energy's analyst price target of NZ$2.57

How far off is Genesis Energy Limited (NZSE:GNE) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

See our latest analysis for Genesis Energy

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF (NZ$, Millions)  NZ$170.0m NZ$127.0m NZ$187.0m NZ$206.0m NZ$72.0m NZ$67.7m NZ$65.4m NZ$64.5m NZ$64.5m NZ$65.0m Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Analyst x1 Analyst x1 Est @ -6.00% Est @ -3.30% Est @ -1.42% Est @ -0.09% Est @ 0.83% Present Value (NZ$, Millions) Discounted @ 6.3%  NZ$160 NZ$112 NZ$156 NZ$161 NZ$53.1 NZ$46.9 NZ$42.7 NZ$39.6 NZ$37.2 NZ$35.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NZ$844m

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 (3.0%) 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 6.3%.

Story Continues

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = NZ$65m× (1 + 3.0%) ÷ (6.3%– 3.0%) = NZ$2.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= NZ$2.0b÷ ( 1 + 6.3%)10= NZ$1.1b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NZ$1.9b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of NZ$2.1, the company appears around fair value at the time of writing. 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.NZSE:GNE Discounted Cash Flow December 16th 2024

The 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 Genesis 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 6.3%, which is based on a levered beta of 0.800. 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 Genesis Energy

Strength

Debt is well covered by cash flow.

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

Weakness

Earnings declined over the past year.

Interest payments on debt are not well covered.

Opportunity

Annual earnings are forecast to grow for the next 3 years.

Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

Dividends are not covered by earnings.

Annual earnings are forecast to grow slower than the New Zealander market.

Looking Ahead:

Whilst important, the DCF calculation 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. 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. For Genesis Energy, there are three pertinent factors you should explore:

Risks: You should be aware of the 3 warning signs for Genesis Energy (1 makes us a bit uncomfortable!) we've uncovered before considering an investment in the company. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for GNE's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors. 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 NZSE 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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