A Look At The Intrinsic Value Of Sempra (NYSE:SRE)

Sempra Energy +0.64%

Sempra Energy

SRE

78.17

+0.64%

Key Insights

  • The projected fair value for Sempra is US$75.04 based on Dividend Discount Model
  • With US$71.49 share price, Sempra appears to be trading close to its estimated fair value
  • Our fair value estimate is 8.9% lower than Sempra's analyst price target of US$82.41

Today we will run through one way of estimating the intrinsic value of Sempra (NYSE:SRE) by taking the expected future cash flows and discounting them to their present value. This will be done using 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Sempra

Crunching The Numbers

As Sempra operates in the integrated utilities sector, we need to calculate the intrinsic value slightly differently. Instead of using free cash flows, which are hard to estimate and often not reported by analysts in this industry, dividends per share (DPS) payments are used. Unless a company pays out the majority of its FCF as a dividend, this method will typically underestimate the value of the stock. We use the Gordon Growth Model, which assumes dividend will grow into perpetuity at a rate that can be sustained. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We then discount this figure to today's value at a cost of equity of 6.2%. Compared to the current share price of US$71.5, the company appears about fair value at a 4.7% 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.

Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)

= US$3.0 / (6.2% – 2.2%)

= US$75.0

dcf
NYSE:SRE Discounted Cash Flow January 30th 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 Sempra 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 6.2%, which is based on a levered beta of 0.800. 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 Sempra

Strength
  • Earnings growth over the past year exceeded the industry.
Weakness
  • Interest payments on debt are not well covered.
  • Dividend is low compared to the top 25% of dividend payers in the Integrated Utilities market.
Opportunity
  • Annual earnings are forecast to grow for the next 4 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Paying a dividend but company has no free cash flows.
  • Annual earnings are forecast to grow slower than the American market.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Sempra, there are three pertinent items you should further research:

  1. Risks: Every company has them, and we've spotted 2 warning signs for Sempra (of which 1 doesn't sit too well with us!) you should know about.
  2. Future Earnings: How does SRE'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.
  3. 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. 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.

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