Key Insights

The projected fair value for NRW Holdings is AU$4.65 based on 2 Stage Free Cash Flow to Equity NRW Holdings is estimated to be 40% undervalued based on current share price of AU$2.78 Our fair value estimate is 53% higher than NRW Holdings' analyst price target of AU$3.04

In this article we are going to estimate the intrinsic value of NRW Holdings Limited (ASX:NWH) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for NRW Holdings

Step By Step Through The Calculation

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 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) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (A$, Millions)  AU$104.0m AU$103.6m AU$127.0m AU$128.2m AU$129.8m AU$131.8m AU$134.0m AU$136.4m AU$138.9m AU$141.6m Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x3 Analyst x1 Est @ 1.25% Est @ 1.50% Est @ 1.67% Est @ 1.80% Est @ 1.88% Est @ 1.94% Present Value (A$, Millions) Discounted @ 7.6%  AU$96.6 AU$89.4 AU$102 AU$95.6 AU$89.9 AU$84.8 AU$80.1 AU$75.8 AU$71.7 AU$67.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$854m



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 (2.1%) 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 7.6%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$142m× (1 + 2.1%) ÷ (7.6%– 2.1%) = AU$2.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$2.6b÷ ( 1 + 7.6%)10= AU$1.3b

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 AU$2.1b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$2.8, the company appears quite undervalued at a 40% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out. dcf

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 NRW 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 7.6%, which is based on a levered beta of 1.109. 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 NRW Holdings

Strength

Debt is not viewed as a risk.

Weakness

Earnings declined over the past year.

Dividend is low compared to the top 25% of dividend payers in the Construction market.

Opportunity

Annual earnings are forecast to grow faster than the Australian market.

Good value based on P/E ratio and estimated fair value.

Threat

Dividends are not covered by cash flow.

Annual revenue is forecast to grow slower than the Australian market.

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. 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. Why is the intrinsic value higher than the current share price? For NRW Holdings, we've put together three further elements you should consider:

Risks: You should be aware of the 1 warning sign for NRW Holdings we've uncovered before considering an investment in the company. Future Earnings: How does NWH'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks 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.