Calculating the Intrinsic Value of PWR Holdings Limited (ASX:PWH)
How far is PWR Holdings Limited (ASX:PWH) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the expected future cash flows and discounting them to the present value. This will be done using the discounted cash flow (DCF) model. Don’t be put off by the jargon, the underlying calculations are actually quite simple.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
See our latest analysis for PWR Holdings
The calculation
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”. To begin with, we need to obtain cash flow estimates for 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, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-Year Free Cash Flow (FCF) Forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF (A$, Millions) | A$23.0 million | A$26.0 million | AU$28.2 million | A$30.0 million | AU$31.5 million | AU$32.8 million | AU$33.9 million | A$34.9 million | AU$35.8 million | AU$36.7 million |
Growth rate estimate Source | Analyst x3 | Analyst x2 | Is at 8.42% | Is at 6.44% | Is at 5.06% | Is at 4.09% | Is at 3.41% | Is at 2.94% | Is at 2.61% | Is at 2.37% |
Present value (A$, millions) discounted at 6.7% | AU$21.5 | AU$22.8 | AU$23.2 | AU$23.1 | AU$22.8 | AU$22.2 | AU$21.5 | AU$20.7 | 19.9 € | AU$19.1 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = AU$216 million
The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.8%. We discount the terminal cash flows to their present value at a cost of equity of 6.7%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = AU$37 million × (1 + 1.8%) ÷ (6.7%–1.8%) = AU$762 million
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= AU$762m÷ ( 1 + 6.7%)^{ten}= AU$397 million
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is A$613 million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of AU$7.2, 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. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. 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 PWR Holdings 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 factors in debt. In this calculation, we used 6.7%, which is based on a leveraged beta of 1.156. 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.
Let’s move on :
While a business valuation is important, it shouldn’t be the only metric to consider when researching a business. The DCF model is not a perfect stock valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. For PWR Holdings, we’ve put together three important factors that you should consider in more detail:
- Risks: Be aware that PWR Holdings displays 1 warning sign in our investment analysis you should know…
- Future earnings: How does PWH’s growth rate 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 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 strong trading fundamentals to see if there are any other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every Australian stock daily, so if you want to find the intrinsic value of any other stock, just 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.