Is California Resources Corporation (NYSE:CRC) Trading At A 49% Discount?

Simply Wall St · 10/15 11:38

Key Insights

  • California Resources' estimated fair value is US$103 based on 2 Stage Free Cash Flow to Equity
  • California Resources' US$53.12 share price signals that it might be 49% undervalued
  • Analyst price target for CRC is US$62.57 which is 40% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of California Resources Corporation (NYSE:CRC) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for California Resources

Is California Resources Fairly Valued?

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. 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.

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$734.0m US$653.0m US$518.0m US$507.0m US$503.8m US$505.4m US$510.3m US$517.5m US$526.6m US$537.0m
Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x1 Analyst x1 Est @ -0.63% Est @ 0.31% Est @ 0.97% Est @ 1.43% Est @ 1.75% Est @ 1.97%
Present Value ($, Millions) Discounted @ 7.5% US$683 US$565 US$417 US$380 US$351 US$328 US$308 US$291 US$275 US$261

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.9b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$537m× (1 + 2.5%) ÷ (7.5%– 2.5%) = US$11b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$11b÷ ( 1 + 7.5%)10= US$5.4b

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$9.2b. 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$53.1, the company appears quite good value at a 49% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NYSE:CRC Discounted Cash Flow October 15th 2024

The 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. 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 California Resources 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 7.5%, which is based on a levered beta of 1.209. 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 California Resources

Strength
  • Debt is well covered by cash flow.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Earnings declined over the past year.
  • Interest payments on debt are not well covered.
  • Dividend is low compared to the top 25% of dividend payers in the Oil and Gas market.
  • Shareholders have been diluted in the past year.
Opportunity
  • Annual earnings are forecast to grow faster than the American market.
  • Trading below our estimate of fair value by more than 20%.
  • Significant insider buying over the past 3 months.
Threat
  • Revenue is forecast to grow slower than 20% per year.

Next Steps:

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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For California Resources, there are three essential items you should further research:

  1. Risks: For instance, we've identified 4 warning signs for California Resources that you should be aware of.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CRC's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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!

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.