Are Resources Connection, Inc. (NASDAQ:RGP) Investors Paying Above The Intrinsic Value?
Key Insights
The projected fair value for Resources Connection is US$10.24 based on 2 Stage Free Cash Flow to Equity
Resources Connection is estimated to be 33% overvalued based on current share price of US$13.60
Analyst price target for RGP is US$16.33, which is 60% above our fair value estimate
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Resources Connection, Inc. (NASDAQ:RGP) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
View our latest analysis for Resources Connection
The Method
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$42.8m | US$62.6m | US$24.0m | US$19.0m | US$16.4m | US$14.9m | US$14.1m | US$13.6m | US$13.4m | US$13.3m |
Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Est @ -20.71% | Est @ -13.83% | Est @ -9.02% | Est @ -5.65% | Est @ -3.29% | Est @ -1.63% | Est @ -0.48% |
Present Value ($, Millions) Discounted @ 6.6% | US$40.1 | US$55.0 | US$19.8 | US$14.7 | US$11.9 | US$10.1 | US$9.0 | US$8.1 | US$7.5 | US$7.0 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$183m
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 6.6%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$13m× (1 + 2.2%) ÷ (6.6%– 2.2%) = US$308m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$308m÷ ( 1 + 6.6%)10= US$162m
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$345m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$13.6, the company appears potentially overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Important 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. 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 Resources Connection 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 6.6%, which is based on a levered beta of 0.885. 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 Resources Connection
Strength
Currently debt free.
Dividends are covered by earnings and cash flows.
Weakness
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Professional Services market.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Good value based on P/E ratio compared to estimated Fair P/E ratio.
Threat
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 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. 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. Can we work out why the company is trading at a premium to intrinsic value? For Resources Connection, there are three important factors you should further examine:
Risks: We feel that you should assess the 1 warning sign for Resources Connection we've flagged before making an investment in the company.
Future Earnings: How does RGP'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 NASDAQGS 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.
