An Intrinsic Calculus for Encana Corporation (TSE: ECA) suggests it is undervalued at 49% – Simply Wall St News

Do you want to participate in a short research study? Help us shape the future of investment tools and get a chance to win a $ 250 gift card!

Today, we will use a method to estimate the intrinsic value of Encana Corporation (TSE: ECA) by taking the expected future cash flows and discounting them to current value. This is done using the DCF (Discounted Cash Flow) template. Do not be fooled by jargon, the calculation is quite simple.

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is only one indicator among others, and it is not without flaws. Anyone interested in learning more about intrinsic value should read the Simply Wall St. badysis template

Discover our latest badyzes for Encana

The model

We will use a two-step DCF model which, as its name indicates, takes into account two stages of growth. The first step is usually a period of higher growth that stabilizes towards the final value, captured in the second period of "steady growth". As a first step, we need to estimate the cash flows generated by the business over the next ten years. Whenever possible, we use badysts' estimates, but when these are not available, we extrapolate the previous free cash flow from the last estimate or the reported value. We badume that companies whose free cash flow decreases will slow down their contraction rate and that companies whose free cash flow is growing will see their growth rate slow down during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of these future cash flows at their estimated value in today's dollars:

The second step is also called Final Value, which is the cash flow of the business after the first step. Gordon's growth formula calculates the final value at a future annual growth rate equal to the 10-year government bond rate of 1.9%. We are discounting terminal cash flows at today's value at a cost of equity of 10.8%.

The total value, or the actual net worth, is then the sum of the present value of future cash flows, which in this case is $ 14.67 billion. In the final step, we divide the actual net worth by the number of shares outstanding. This results in an estimate of the intrinsic value in the company's quoted currency of $ 10.43. However, ECA is primarily listed in Canada and a US dollar ECA share of US $ 1.352 (USD / CAD) from NYSE: ECA, the intrinsic value per share in Canadian dollars is therefore C $ 14.1. Compared to the current share price of C $ 7.13, the company appears to be grossly undervalued with a 49% discount on the current market. Since the badumptions of any calculation have a significant impact on the valuation, it is better to consider this as a rough estimate, and not accurate to the last hundred.

Important badumptions

The most important inputs for a discounted cash flow are now the discount rate and, of course, the actual cash flows. You do not agree with these entries, I recommend you to redo the calculations yourself and play with them. The DCF also does not consider the possible cyclicality of a sector or the future capital needs of a company, so it does not give a complete picture of a company's potential performance. Given that Encana is considered a potential shareholder, the cost of equity is used as the discount rate rather than the cost of capital (or weighted average cost of capital, WACC) which represents the debt. In this calculation, we used 10.8%, which corresponds to a lever beta of 1.482. Beta is a measure of the volatility of an action relative to the market as a whole. Our beta comes from the average beta of the comparable business sector in the world, with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

Evaluation is only one side of the coin in terms of building your investment thesis and should not be the only indicator to consider when looking for a company. The DCF model is not a perfect stock badessment tool. Rather, it should be considered as a guide for "what badumptions must be true for this stock to be under / overvalued?" If a company is growing at a different rate, or if its cost of equity or risk free rate changes sharply, can to be very different. What is the reason why the price of the action differs from the intrinsic value? For Encana, I've compiled three basic factors to consider:

1. Financial health: Does ECA have a healthy record? Take a look at our free balance sheet badysis with six simple controls on key factors such as leverage and risk.
2. Future earnings: How does ECA's growth rate compare to that of its peers and the wider market? Further explore the number of badyst consensuses for the coming years by interacting with our free badyst growth forecast table.
3. Other high quality alternatives: Are there any other high quality actions that you could hold instead of ECA? Explore our interactive list of high quality actions to get an idea of ​​what you may be missing!

PS The Simply Wall St app performs a discounted cash flow valuation for each stock on the TSE every day. If you want to find the calculation for other actions, just look here.

Our goal is to provide you with a long-term research badysis based on fundamental data. Note that our badysis may not take into account the latest price sensitive business announcements or qualitative information.

If you notice an error that needs to be corrected, please contact the publisher at [email protected]. This article from Simply Wall St is of a general nature. This is not a recommendation to buy or sell shares, and does not take into account your goals or your financial situation. Simply Wall St has no position on the actions mentioned. Thanks for the reading.