In this article I am going to calculate the intrinsic value of GTT Communications Inc (NYSE:GTT) by projecting its future cash flows and then discounting them to today’s value. This is done using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in June 2018 so be sure check out the updated calculation by following the link below. Check out our latest analysis for GTT Communications
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
|Levered FCF ($, Millions)||$76.57||$192.87||$278.15||$374.96||$442.76|
|Source||Analyst x4||Analyst x5||Analyst x2||Analyst x1||Analyst x1|
|Present Value Discounted @ 15.23%||$66.45||$145.26||$181.80||$212.68||$217.94|
Present Value of 5-year Cash Flow (PVCF)= US$824.13m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 15.2%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$442.76m × (1 + 2.9%) ÷ (15.2% – 2.9%) = US$3.71b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$3.71b ÷ ( 1 + 15.2%)5 = US$1.83b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$2.65b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $48.61. Relative to the current share price of $49.2, the stock is fair value, maybe slightly overvalued at the time of writing.
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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at GTT Communications as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 15.2%, which is based on a levered beta of 1.742. This is derived from the Bottom-Up Beta method based on 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 shouldn’t be the only metric you look at when researching a company. For GTT, I’ve compiled three key aspects you should look at:
- Financial Health: Does GTT have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does GTT’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: Are there other high quality stocks you could be holding instead of GTT? 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 for every stock on the NYSE every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.