Today, we’ll walk through one way to estimate the intrinsic value of Antero Resources Corporation (NYSE:AR) by taking the company’s expected future cash flows and discounting them to the present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it may seem quite complex.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.
See our latest analysis for Antero Resources
The method
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
Estimated free cash flow (FCF) over 10 years
| 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
| Leveraged FCF ($, millions) | $1.27 billion | $1.20 billion | $753.0 million | $540.0 million | $553.0 million | $447.2 million | $389.9 million | $357.2 million | $338.3 million | $327.7 million |
| Growth rate estimate Source | Analyst x5 | Analyst x6 | Analyst x2 | Analyst x1 | Analyst x1 | Is @ -19.12% | East @ -12.81% | Is @ -8.39% | East @ -5.3% | Is @ -3.13% |
| Present value (in millions of dollars) discounted at 9.3% | $1,200 | $1,000 | $576 | $378 | $354 | $262 | $209 | $175 | $151 | $134 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $4.4 billion
The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 9.3%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$328 million × (1 + 1.9%) ÷ (9.3%–1.9%) = US$4.5 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $4.5 billion ÷ (1 + 9.3%)ten= $1.8 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $6.2 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of US$22.5, the company appears around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in a different galaxy. Keep that in mind.
Important assumptions
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Antero 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 takes debt into account. In this calculation, we used 9.3%, which is based on a leveraged beta of 1.751. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Look forward:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won’t be the only piece of analysis you look at for a company. DCF models are not the be-all and end-all of investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. For Antero Resources, we’ve compiled three fundamentals you should dig into:
- Risks: Every business has them, and we’ve spotted 2 warning signs for Antero Resources you should know.
- Future earnings: How does the growth rate of AR compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. The Simply Wall St app performs a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.