Oasis Petroleum Inc. (NASDAQ:OAS) Shares Could Be 24% Above Their Intrinsic Value Estimate

Oasis Petroleum Inc. (NASDAQ:OAS) Shares Could Be 24% Above Their Intrinsic Value Estimate

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<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="In this article we are going to estimate the intrinsic value of Oasis Petroleum Inc. (NASDAQ:OAS) by taking the forecast future cash flows of the company and discounting them back to today’s value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!” data-reactid=”28″>In this article we are going to estimate the intrinsic value of Oasis Petroleum Inc. (NASDAQ:OAS) by taking the forecast future cash flows of the company and discounting them back to today’s value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.” data-reactid=”29″>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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content=" See our latest analysis for Oasis Petroleum ” data-reactid=”30″> See our latest analysis for Oasis Petroleum

Crunching the numbers

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 begin with, we have to get estimates of 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, so we discount the value of these future cash flows to their estimated value in today’s dollars:

10-year free cash flow (FCF) estimate

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) -US$62.8m US$23.7m US$23.7m US$23.7m US$23.9m US$24.1m US$24.5m US$24.9m US$25.4m US$25.8m
Growth Rate Estimate Source Analyst x3 Analyst x1 Analyst x1 Analyst x1 Est @ 0.67% Est @ 1.13% Est @ 1.46% Est @ 1.69% Est @ 1.85% Est @ 1.96%
Present Value ($, Millions) Discounted @ 14% -US$54.9 US$18.2 US$15.9 US$13.9 US$12.3 US$10.9 US$9.6 US$8.6 US$7.6 US$6.8

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$48m” data-reactid=”41″>(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$48m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 14%.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$26m× (1 + 2.2%) ÷ (14%– 2.2%) = US$220m” data-reactid=”43″>Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$26m× (1 + 2.2%) ÷ (14%– 2.2%) = US$220m

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$220m÷ ( 1 + 14%)10= US$58m” data-reactid=”44″>Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$220m÷ ( 1 + 14%)10= US$58m

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$106m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$0.4, the company appears slightly overvalued 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.

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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 Oasis Petroleum 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 14%, which is based on a levered beta of 2.000. 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.

Looking Ahead:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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 exceeding the intrinsic value? For Oasis Petroleum, we’ve compiled three additional aspects you should explore:

  1. Risks: Every company has them, and we’ve spotted 1 warning sign for Oasis Petroleum you should know about.
  2. Future Earnings: How does OAS’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.
  3. 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!

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.” data-reactid=”70″>PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="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.” data-reactid=”71″>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.

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