Is There An Opportunity With OneSpaWorld Holdings Limited's (NASDAQ:OSW) 48% Undervaluation?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, OneSpaWorld Holdings fair value estimate is US$21.49

• OneSpaWorld Holdings' US$11.10 share price signals that it might be 48% undervalued

• The US$15.25 analyst price target for OSW is 29% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of OneSpaWorld Holdings Limited (NASDAQ:OSW) by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

See our latest analysis for OneSpaWorld Holdings

The Model

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$60.5m	US$68.9m	US$82.5m	US$101.0m	US$113.7m	US$123.0m	US$130.9m	US$137.6m	US$143.4m	US$148.5m
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x2	Analyst x1	Analyst x1	Est @ 8.24%	Est @ 6.40%	Est @ 5.11%	Est @ 4.21%	Est @ 3.58%
Present Value ($, Millions) Discounted @ 7.5%	US$56.2	US$59.6	US$66.5	US$75.7	US$79.2	US$79.8	US$79.0	US$77.2	US$74.9	US$72.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$720m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$149m× (1 + 2.1%) ÷ (7.5%– 2.1%) = US$2.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$2.8b÷ ( 1 + 7.5%)¹⁰= US$1.4b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$2.1b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$11.1, the company appears quite undervalued at a 48% 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.

dcf

The Assumptions

We would point out that 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 OneSpaWorld Holdings 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 7.5%, which is based on a levered beta of 0.905. 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 OneSpaWorld Holdings

Strength

• No major strengths identified for OSW.

Weakness

• Interest payments on debt are not well covered.

• Shareholders have been diluted in the past year.

Opportunity

• Annual earnings are forecast to grow faster than the American market.

• Trading below our estimate of fair value by more than 20%.

Threat

• Debt is not well covered by operating cash flow.

• Revenue is forecast to grow slower than 20% per year.

Moving On:

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. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For OneSpaWorld Holdings, we've put together three important aspects you should consider:

1. Risks: For example, we've discovered 3 warning signs for OneSpaWorld Holdings (1 is significant!) that you should be aware of before investing here.

2. Future Earnings: How does OSW'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.

3. 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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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