PFSweb, Inc. (NASDAQ: PFSW) shares could be 25% lower than their intrinsic value estimate
Today we’re going to review a valuation method used to estimate the attractiveness of PFSweb, Inc. (NASDAQ: PFSW) as an investment opportunity by projecting its future cash flows and then discounting them. at today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
We generally believe that the value of a business is the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.
The calculation
We use the 2-step growth model, which simply means that we take into account two stages of business growth. In 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 estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated 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 down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :
10-year free cash flow (FCF) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF ($, Millions) | US $ 15.1 million | US $ 16.9 million | US $ 18.4 million | US $ 19.6 million | US $ 20.7 million | US $ 21.6 million | $ 22.4 million | US $ 23.1 million | US $ 23.7 million | US $ 24.3 million |
Source of estimated growth rate | Analyst x1 | Est @ 11.76% | Est @ 8.82% | Est @ 6.76% | East @ 5.32% | East @ 4.31% | East @ 3.61% | Est @ 3.11% | East @ 2.77% | Is 2.53% |
Present value (in millions of dollars) discounted at 7.2% | US $ 14.1 | $ 14.7 | $ 14.9 | US $ 14.9 | $ 14.6 | US $ 14.2 | $ 13.8 | US $ 13.2 | $ 12.7 | US $ 12.1 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 139 million
It is now a matter of calculating the Terminal Value, which takes into account all future cash flows after this 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 7.2%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = US $ 24 million × (1 + 2.0%) ÷ (7.2% to 2.0%) = US $ 474 million
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= US $ 474 million ÷ (1 + 7.2%)^{ten}= US $ 236 million
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $ 375 million. In the last step, we divide the equity value by the number of shares outstanding. From the current share price of US $ 13.3, the company appears to be slightly undervalued at a 25% 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.
NasdaqCM: PFSW Discounted cash flow November 9, 2021
The hypotheses
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. If you don’t agree with these results, try the calculation yourself and play with the 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 full picture of a company’s potential performance. Since we view PFSweb 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 debt into account. In this calculation, we used 7.2%, which is based on a leveraged beta of 1.194. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
To move on :
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a business. It is not possible to achieve a rock-solid valuation with a DCF model. 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. Can we understand why the company trades at a discount to its intrinsic value? For PFSweb, we’ve compiled three additional factors to consider:
- Risks: For example, we discovered 2 warning signs for PFSweb which you should know before investing here.
- Future benefits: How does PFSW’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQCM share. If you want to find the calculation for other actions, just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is 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 material. Simply Wall St has no position in the mentioned stocks.
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