An Intrinsic Calculation For Argan, Inc. (NYSE:AGX) Suggests It's 28% Undervalued
Key Insights
The projected fair value for Argan is US$65.24 based on 2 Stage Free Cash Flow to Equity
Current share price of US$46.74 suggests Argan is potentially 28% undervalued
When compared to theindustry average discount to fair value of 11%, Argan's competitors seem to be trading at a lesser discount
Does the March share price for Argan, Inc. (NYSE:AGX) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
See our latest analysis for Argan
The Method
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$75.6m | US$57.7m | US$50.9m | US$47.1m | US$44.9m | US$43.8m | US$43.4m | US$43.3m | US$43.6m | US$44.1m |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Analyst x2 | Est @ -7.45% | Est @ -4.53% | Est @ -2.48% | Est @ -1.05% | Est @ -0.05% | Est @ 0.65% | Est @ 1.14% |
Present Value ($, Millions) Discounted @ 6.9% | US$70.7 | US$50.5 | US$41.7 | US$36.1 | US$32.3 | US$29.4 | US$27.3 | US$25.5 | US$24.0 | US$22.7 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$360m
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 (2.3%) 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 6.9%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$44m× (1 + 2.3%) ÷ (6.9%– 2.3%) = US$988m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$988m÷ ( 1 + 6.9%)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$869m. 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$46.7, the company appears a touch undervalued at a 28% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Argan 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 6.9%, which is based on a levered beta of 0.993. 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 Argan
Strength
Earnings growth over the past year exceeded the industry.
Currently debt free.
Dividends are covered by earnings and cash flows.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Construction market.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Good value based on P/E ratio and estimated fair value.
Threat
No apparent threats visible for AGX.
Looking Ahead:
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 company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Argan, we've compiled three pertinent factors you should assess:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Argan , and understanding this should be part of your investment process.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AGX'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE 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.
