In this article we are going to estimate the intrinsic value of Cardtronics plc (NASDAQ:CATM) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Step by step through the calculation
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable 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
|Levered FCF ($, Millions)||US$109.4m||US$130.6m||US$133.2m||US$142.3m||US$149.3m||US$155.4m||US$160.9m||US$166.0m||US$170.7m||US$175.3m|
|Growth Rate Estimate Source||Analyst x3||Analyst x1||Analyst x1||Analyst x1||Est @ 4.91%||Est @ 4.1%||Est @ 3.54%||Est @ 3.14%||Est @ 2.87%||Est @ 2.67%|
|Present Value ($, Millions) Discounted @ 13%||US$97.0||US$103||US$92.8||US$87.9||US$81.8||US$75.5||US$69.3||US$63.4||US$57.8||US$52.6|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$780m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 13%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$175m× (1 + 2.2%) ÷ (13%– 2.2%) = US$1.7b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.7b÷ ( 1 + 13%)10= US$509m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$1.3b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$23.2, the company appears about fair value at a 20% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. 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 Cardtronics 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 13%, which is based on a levered beta of 1.759. 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.
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Cardtronics, there are three essential items you should explore:
- Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Cardtronics (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CATM's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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. 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 article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.