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Marathon Oil Corporation's (NYSE:MRO) Intrinsic Value Is Potentially 64% Above Its Share Price

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Marathon Oil fair value estimate is US$39.45

  • Current share price of US$24.02 suggests Marathon Oil is potentially 39% undervalued

  • Our fair value estimate is 21% higher than Marathon Oil's analyst price target of US$32.74

Today we will run through one way of estimating the intrinsic value of Marathon Oil Corporation (NYSE:MRO) 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. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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Check out our latest analysis for Marathon Oil

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) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$2.27b

US$2.52b

US$2.34b

US$2.29b

US$2.23b

US$2.20b

US$2.19b

US$2.20b

US$2.23b

US$2.25b

Growth Rate Estimate Source

Analyst x10

Analyst x10

Analyst x7

Analyst x2

Analyst x1

Est @ -1.22%

Est @ -0.22%

Est @ 0.48%

Est @ 0.97%

Est @ 1.31%

Present Value ($, Millions) Discounted @ 10%

US$2.1k

US$2.1k

US$1.7k

US$1.5k

US$1.4k

US$1.2k

US$1.1k

US$1.0k

US$919

US$844

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$14b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$2.3b× (1 + 2.1%) ÷ (10%– 2.1%) = US$28b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$28b÷ ( 1 + 10%)10= US$10b

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$24b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$24.0, the company appears quite undervalued at a 39% 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.

dcf
dcf

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. 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 Marathon Oil 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 1.382. 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 Marathon Oil

Strength

  • Debt is well covered by earnings and cashflows.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Earnings growth over the past year underperformed the Oil and Gas industry.

  • Dividend is low compared to the top 25% of dividend payers in the Oil and Gas market.

Opportunity

  • Good value based on P/E ratio and estimated fair value.

Threat

  • Annual earnings are forecast to decline for the next 3 years.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Marathon Oil, we've put together three essential elements you should consider:

  1. Risks: For example, we've discovered 3 warning signs for Marathon Oil (1 can't be ignored!) that you should be aware of before investing here.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for MRO'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE 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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