An Intrinsic Calculation For Douglas Dynamics, Inc. (NYSE:PLOW) Suggests It's 26% Undervalued
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Douglas Dynamics fair value estimate is US$36.02
Douglas Dynamics' US$26.51 share price signals that it might be 26% undervalued
The US$40.67 analyst price target for PLOW is 13% more than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Douglas Dynamics, Inc. (NYSE:PLOW) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for Douglas Dynamics
Step By Step Through The Calculation
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$52.3m | US$53.6m | US$54.8m | US$56.0m | US$57.3m | US$58.6m | US$59.9m | US$61.2m | US$62.6m | US$63.9m |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Est @ 2.25% | Est @ 2.24% | Est @ 2.23% | Est @ 2.23% | Est @ 2.23% | Est @ 2.22% | Est @ 2.22% | Est @ 2.22% |
Present Value ($, Millions) Discounted @ 8.6% | US$48.2 | US$45.5 | US$42.8 | US$40.3 | US$38.0 | US$35.8 | US$33.7 | US$31.7 | US$29.9 | US$28.1 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$374m
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 8.6%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$64m× (1 + 2.2%) ÷ (8.6%– 2.2%) = US$1.0b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.0b÷ ( 1 + 8.6%)10= US$454m
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$828m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$26.5, the company appears a touch undervalued at a 26% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Important Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Douglas Dynamics 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 8.6%, which is based on a levered beta of 1.267. 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 Douglas Dynamics
Strength
Debt is well covered by earnings.
Weakness
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Machinery market.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Good value based on P/E ratio and estimated fair value.
Significant insider buying over the past 3 months.
Threat
Debt is not well covered by operating cash flow.
Dividends are not covered by earnings.
Annual revenue is forecast to grow slower than the American market.
Next Steps:
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. 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. What is the reason for the share price sitting below the intrinsic value? For Douglas Dynamics, there are three fundamental aspects you should further research:
Risks: As an example, we've found 2 warning signs for Douglas Dynamics (1 makes us a bit uncomfortable!) that you need to consider before investing here.
Future Earnings: How does PLOW'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 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.
