Using the 2 Stage Free Cash Flow to Equity, Casella Waste Systems fair value estimate is US$62.13
Casella Waste Systems is estimated to be 27% overvalued based on current share price of US$78.77
Our fair value estimate is 38% lower than Casella Waste Systems' analyst price target of US$100.00
Today we will run through one way of estimating the intrinsic value of Casella Waste Systems, Inc. (NASDAQ:CWST) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
Levered FCF ($, Millions)
Growth Rate Estimate Source
Est @ 7.35%
Est @ 5.79%
Est @ 4.70%
Est @ 3.93%
Est @ 3.40%
Est @ 3.02%
Est @ 2.76%
Est @ 2.58%
Present Value ($, Millions) Discounted @ 7.1%
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.3b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 have used the 5-year average of the 10-year government bond yield (2.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.1%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$222m× (1 + 2.2%) ÷ (7.1%– 2.2%) = US$4.6b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.6b÷ ( 1 + 7.1%)10= US$2.3b
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$3.6b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$78.8, the company appears slightly overvalued at the time of writing. 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.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Casella Waste Systems 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 7.1%, which is based on a levered beta of 0.992. 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.
SWOT Analysis for Casella Waste Systems
Debt is well covered by earnings and cashflows.
Earnings declined over the past year.
Expensive based on P/E ratio and estimated fair value.
Shareholders have been diluted in the past year.
Annual earnings are forecast to grow faster than the American market.
Revenue is forecast to grow slower than 20% per year.
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value lower than the current share price? For Casella Waste Systems, there are three pertinent aspects you should further research:
Risks: As an example, we've found 4 warning signs for Casella Waste Systems that you need to consider before investing here.
Future Earnings: How does CWST's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.