A look at the fair value of Global Water Resources, Inc. (NASDAQ: GWRS)
How far is Global Water Resources, Inc. (NASDAQ: GWRS) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock’s price is fair by taking expected future cash flows and discounting them to their present value. The DCF (Discounted Cash Flow) model is the tool we will apply to do this. There really isn’t much to do, although it might seem quite complex.
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we need to get cash flow estimates for the next ten years. Since no analysts estimate of free cash flow is available to us, we have extrapolated past free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
Typically, 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 present value:
10-year Free Cash Flow (FCF) forecast
|Levered FCF ($, million)||$ 9.86 million||$ 12.2 million||$ 14.4 million||$ 16.2 million||$ 17.8 million||$ 19.0 million||$ 20.1 million||$ 21.1 million||$ 21.9 million||22.6 million USD|
|Source of estimated growth rate||Is 33.49%||Is 24.04%||Is at 17.42%||Est @ 12.79%||Is 9.55%||Is 7.28%||Is 5.7%||Is 4.58%||Is 3.81%||Is at 3.26%|
|Present value ($, millions) discounted at 5.8%||$ 9.3||$ 10.9||$ 12.1||$ 12.9||$ 13.4||$ 13.6||$ 13.6||$ 13.4||$ 13.2||$ 12.9|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = USD 125 million
Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 5.8%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = $ 23 million × (1 + 2.0%) ÷ (5.8% – 2.0%) = $ 609 million
Present value of terminal value (PVTV)= TV / (1 + r)ten= $ 609 million ÷ (1 + 5.8%)ten= 348 million USD
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is US $ 473 million. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of US $ 17.0, the company appears to have fair value at a 19% discount from the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
NasdaqGM: GWRS Discounted Cash Flow May 16, 2021
We draw your attention to the fact that the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the math yourself and play around with it. 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 view Global Water 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 into account debt. In this calculation, we used 5.8%, which is based on a leverage beta of 0.800. Beta is a measure of the volatility of a stock, relative 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.
While important, the DCF calculation is just one of the many factors you need to assess for a business. DCF models are not the alpha and omega 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 dramatically change the overall result. For Global Water Resources, we have put together three important factors to consider:
- Risks: Take risks, for example – Global Water Resources has 4 warning signs (and 1 which is a bit rude) we think you should know.
- Future income: How does GWRS’s growth rate compare to its peers and to the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQGM share. If you want to find the calculation for other actions, just search here.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
Do you have any comments on this article? Concerned about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.