In this article we are going to estimate the intrinsic value of AECOM (NYSE:ACM) by projecting its future cash flows and then discounting them to today’s value. One way to achieve this is by employing 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis 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 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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
|Levered FCF ($, Millions)||US$507.8m||US$529.5m||US$558.5m||US$610.0m||US$682.0m||US$727.0m||US$765.0m||US$797.7m||US$826.4m||US$852.3m|
|Growth Rate Estimate Source||Analyst x3||Analyst x3||Analyst x2||Analyst x1||Analyst x1||Est @ 6.6%||Est @ 5.23%||Est @ 4.27%||Est @ 3.6%||Est @ 3.13%|
|Present Value ($, Millions) Discounted @ 8.3%||US$469||US$452||US$440||US$444||US$458||US$451||US$439||US$423||US$404||US$385|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.4b
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 2.0%. We discount the terminal cash flows to today’s value at a cost of equity of 8.3%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$852m× (1 + 2.0%) ÷ (8.3%– 2.0%) = US$14b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$14b÷ ( 1 + 8.3%)10= US$6.3b
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$11b. The last step is to then divide the equity value by the number of shares…
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