Are Investors Undervaluing EVERTEC, Inc. (NYSE:EVTC) By 49%?
In this article we are going to estimate the intrinsic value of EVERTEC, Inc. (NYSE:EVTC) by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. 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.
See our latest analysis for EVERTEC
What's the estimated valuation?
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. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Levered FCF ($, Millions) | US$217.4m | US$243.6m | US$265.6m | US$284.0m | US$299.4m | US$312.6m | US$324.0m | US$334.2m | US$343.5m | US$352.3m |
Growth Rate Estimate Source | Est @ 16.41% | Est @ 12.08% | Est @ 9.04% | Est @ 6.92% | Est @ 5.43% | Est @ 4.39% | Est @ 3.66% | Est @ 3.15% | Est @ 2.79% | Est @ 2.54% |
Present Value ($, Millions) Discounted @ 6.9% | US$203 | US$213 | US$218 | US$218 | US$215 | US$210 | US$204 | US$196 | US$189 | US$181 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.0b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.0%) 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)= FCF2031 × (1 + g) ÷ (r – g) = US$352m× (1 + 2.0%) ÷ (6.9%– 2.0%) = US$7.3b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$7.3b÷ ( 1 + 6.9%)10= US$3.8b
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$5.8b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$42.0, the company appears quite undervalued at a 49% 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.
The assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 EVERTEC 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 1.120. 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.
Looking Ahead:
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. 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 EVERTEC, we've compiled three important items you should further examine:
Risks: Take risks, for example - EVERTEC has 1 warning sign we think you should be aware of.
Future Earnings: How does EVTC'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.
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.
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