Does the February share price for Kodiak Gas Services, Inc. (NYSE:KGS) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
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.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF ($, Millions)
US$214.1m
US$256.7m
US$256.0m
US$257.5m
US$260.6m
US$264.9m
US$270.0m
US$275.7m
US$282.0m
US$288.8m
Growth Rate Estimate Source
Analyst x4
Analyst x3
Analyst x1
Est @ 0.60%
Est @ 1.20%
Est @ 1.63%
Est @ 1.93%
Est @ 2.13%
Est @ 2.28%
Est @ 2.38%
Present Value ($, Millions) Discounted @ 9.4%
US$196
US$214
US$195
US$179
US$166
US$154
US$144
US$134
US$125
US$117
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$1.6b
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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 9.4%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.3b÷ ( 1 + 9.4%)10= US$1.8b
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$3.4b. 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$45.3, the company appears slightly overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
NYSE:KGS Discounted Cash Flow February 9th 2025
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Kodiak Gas Services 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 9.4%, which is based on a levered beta of 1.657. 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 Kodiak Gas Services
Strength
No major strengths identified for KGS.
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 Energy Services market.
Expensive based on P/S ratio and estimated fair value.
Shareholders have been diluted in the past year.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Threat
Debt is not well covered by operating cash flow.
Dividends are not covered by earnings.
Revenue is forecast to grow slower than 20% per year.
Looking Ahead:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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 premium to intrinsic value? For Kodiak Gas Services, we've put together three important elements you should assess:
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for KGS's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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.
