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Construction Partners, Inc. (NASDAQ:ROAD) Shares Could Be 49% Below Their Intrinsic Value Estimate

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Construction Partners fair value estimate is US$58.40

  • Current share price of US$30.06 suggests Construction Partners is potentially 49% undervalued

  • The US$33.00 analyst price target for ROAD is 43% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Construction Partners, Inc. (NASDAQ:ROAD) by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

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View our latest analysis for Construction Partners

Crunching The Numbers

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) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$47.5m

US$53.1m

US$86.5m

US$125.2m

US$165.1m

US$203.1m

US$237.0m

US$266.2m

US$290.9m

US$311.6m

Growth Rate Estimate Source

Analyst x4

Analyst x4

Est @ 62.95%

Est @ 44.70%

Est @ 31.92%

Est @ 22.98%

Est @ 16.72%

Est @ 12.34%

Est @ 9.27%

Est @ 7.12%

Present Value ($, Millions) Discounted @ 8.8%

US$43.6

US$44.9

US$67.2

US$89.4

US$108

US$123

US$132

US$136

US$137

US$135

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.0b

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 8.8%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$312m× (1 + 2.1%) ÷ (8.8%– 2.1%) = US$4.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.8b÷ ( 1 + 8.8%)10= US$2.1b

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$3.1b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$30.1, the company appears quite undervalued at a 49% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
dcf

Important Assumptions

Now 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 Construction Partners 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 8.8%, which is based on a levered beta of 1.120. 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 Construction Partners

Strength

  • Earnings growth over the past year exceeded the industry.

Weakness

  • Interest payments on debt are not well covered.

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.

Looking Ahead:

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. DCF models are not the be-all and end-all of investment valuation. 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. Can we work out why the company is trading at a discount to intrinsic value? For Construction Partners, there are three further items you should further research:

  1. Risks: Take risks, for example - Construction Partners has 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ROAD's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  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. 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.

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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