Fair value estimate of Aviat Networks, Inc. (NASDAQ: AVNW)
In this article, we’ll estimate the intrinsic value of Aviat Networks, Inc. (NASDAQ: AVNW) by taking expected future cash flows and discounting them to their present value. We will therefore take advantage of the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it might seem quite complex.
There are many ways that businesses can be valued, so we would like to stress that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should have a read of the Simply Wall St.
The calculation
We are going to use a two-step 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 “steady growth”. 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.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) forecast
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF ($, million) | 13.5 million USD | $ 14.8 million | $ 16.0 million | $ 17.0 million | $ 17.8 million | 18.5 million USD | $ 19.1 million | $ 19.7 million | $ 20.2 million | $ 20.7 million |
Source of estimated growth rate | Is 13.72% | Is 10.21% | Is 7.76% | Is 6.04% | Is 4.84% | Is 4% | Is 3.41% | Is 3% | Is 2.71% | Is 2.51% |
Present value ($, million) discounted at 7.0% | $ 12.6 | $ 13.0 | $ 13.1 | $ 13.0 | $ 12.7 | $ 12.3 | US $ 11.9 | US $ 11.5 | US $ 11.0 | $ 10.6 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 121 million USD
Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10 year “growth” period, we discount future cash flows to present value, using a cost of equity of 7.0%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = $ 21 million × (1 + 2.0%) ÷ (7.0% – 2.0%) = $ 429 million
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $ 429 million ÷ (1 + 7.0%)^{ten}= 218 million USD
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 339 million. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of US $ 32.4, the company appears to be 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 another galaxy. Keep this in mind.
NasdaqGS: AVNW Discounted Cash Flow May 2, 2021
The hypotheses
Now the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. Part of investing is making your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. 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. Because we view Aviat Networks 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 7.0%, which is based on a leveraged beta of 0.944. 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.
To move on:
While a business valuation is important, ideally it won’t be the only analysis you review for a business. It is not possible to obtain an infallible valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. For Aviat Networks, we’ve compiled three basic things you should research further:
- Risks: As an example, we found 2 warning signs for Aviat Networks that you need to take into account before investing here.
- Future income: How does AVNW’s growth rate compare to its peers and the overall market? 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. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock 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.
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