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Is There An Opportunity With SPX Corporation's (NYSE:SPXC) 41% Undervaluation?

In this article we are going to estimate the intrinsic value of SPX Corporation (NYSE:SPXC) by estimating the company's future cash flows and discounting them to their present value. This is done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 SPX

What's the value?

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. 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 are 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

Levered FCF ($, Millions)

US$131

US$155

US$175

US$192

US$207

US$220

US$231

US$241

US$251

US$260

Growth Rate Estimate Source

Analyst x2

Analyst x1

Est @ 12.75%

Est @ 9.74%

Est @ 7.64%

Est @ 6.17%

Est @ 5.14%

Est @ 4.41%

Est @ 3.91%

Est @ 3.56%

Present Value ($, Millions) Discounted @ 9.76%

US$119

US$129

US$132

US$132

US$130

US$126

US$120

US$114

US$108

US$102

Present Value of 10-year Cash Flow (PVCF)= $1.21b

"Est" = FCF growth rate estimated by Simply Wall St

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 10-year government bond rate (2.7%) 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 9.8%.

Terminal Value (TV) = FCF2029 × (1 + g) ÷ (r – g) = US$260m × (1 + 2.7%) ÷ (9.8% – 2.7%) = US$3.8b

Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = $US$3.8b ÷ ( 1 + 9.8%)10 = $1.49b

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 $2.71b. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of $61.71. Relative to the current share price of $36.53, the company appears quite undervalued at a 41% discount to what it is available for right now. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

NYSE:SPXC Intrinsic value, April 23rd 2019
NYSE:SPXC Intrinsic value, April 23rd 2019

Important 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 SPX 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 9.8%, which is based on a levered beta of 1.18. 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.

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. 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?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price to differ from the intrinsic value? For SPX, There are three pertinent factors you should look at:

  1. Financial Health: Does SPXC 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.

  2. Future Earnings: How does SPXC'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: Are there other high quality stocks you could be holding instead of SPXC? 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 US stock every day, so if you want to find the intrinsic value of any other stock just search here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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