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Is There An Opportunity With Occidental Petroleum Corporation’s (NYSE:OXY) 43% Undervaluation?

Updated: 09-11-2024, 02.03 PM

Using the 2 Stage Free Cash Flow to Equity, Occidental Petroleum fair value estimate is US$88.10
Occidental Petroleum is estimated to be 43% undervalued based on current share price of US$50.53
The US$63.67 analyst price target for OXY is 28% less than our estimate of fair value

Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of Occidental Petroleum Corporation (NYSE:OXY) as an investment opportunity by taking the expected future cash flows and discounting them to today’s value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they’re fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Occidental Petroleum

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:

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$4.71b	US$5.62b	US$5.23b	US$5.08b	US$5.02b	US$5.03b	US$5.07b	US$5.13b	US$5.22b	US$5.33b
Growth Rate Estimate Source	Analyst x5	Analyst x5	Analyst x2	Analyst x2	Est @ -1.07%	Est @ 0.04%	Est @ 0.81%	Est @ 1.35%	Est @ 1.73%	Est @ 2.00%
Present Value ($, Millions) Discounted @ 7.9%	US$4.4k	US$4.8k	US$4.2k	US$3.7k	US$3.4k	US$3.2k	US$3.0k	US$2.8k	US$2.6k	US$2.5k

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$35b

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 2.6%. We discount the terminal cash flows to today’s value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$5.3b× (1 + 2.6%) ÷ (7.9%– 2.6%) = US$103b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$103b÷ ( 1 + 7.9%)¹⁰= US$48b

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$82b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$50.5, the company appears quite good value at a 43% 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.

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 Occidental 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 7.9%, which is based on a levered beta of 1.292. 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.

Strength

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Opportunity

Threat

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won’t be the sole piece of analysis you scrutinize 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 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. Why is the intrinsic value higher than the current share price? For Occidental Petroleum, there are three fundamental items you should assess:

Risks: Case in point, we’ve spotted 3 warning signs for Occidental Petroleum you should be aware of.
Future Earnings: How does OXY’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.
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.

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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.