UK markets close in 3 hours 32 minutes
  • FTSE 100

    6,401.45
    +67.61 (+1.07%)
     
  • FTSE 250

    19,721.08
    +138.73 (+0.71%)
     
  • AIM

    1,033.75
    -1.29 (-0.12%)
     
  • GBP/EUR

    1.1223
    -0.0030 (-0.26%)
     
  • GBP/USD

    1.3315
    -0.0007 (-0.05%)
     
  • BTC-GBP

    14,321.02
    +474.87 (+3.43%)
     
  • CMC Crypto 200

    375.09
    +13.66 (+3.78%)
     
  • S&P 500

    3,577.59
    +20.05 (+0.56%)
     
  • DOW

    29,591.27
    +327.79 (+1.12%)
     
  • CRUDE OIL

    43.65
    +0.59 (+1.37%)
     
  • GOLD FUTURES

    1,807.80
    -30.00 (-1.63%)
     
  • NIKKEI 225

    26,165.59
    +638.22 (+2.50%)
     
  • HANG SENG

    26,588.20
    +102.00 (+0.39%)
     
  • DAX

    13,251.07
    +124.10 (+0.95%)
     
  • CAC 40

    5,562.58
    +70.43 (+1.28%)
     

Are Investors Undervaluing SPX Corporation (NYSE:SPXC) By 37%?

Simply Wall St
·6-min read

In this article we are going to estimate the intrinsic value of SPX Corporation (NYSE:SPXC) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for SPX

What's the estimated valuation?

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

Levered FCF ($, Millions)

US$179.0m

US$201.8m

US$221.2m

US$237.5m

US$251.4m

US$263.3m

US$273.9m

US$283.3m

US$292.1m

US$300.3m

Growth Rate Estimate Source

Analyst x2

Est @ 12.76%

Est @ 9.6%

Est @ 7.38%

Est @ 5.83%

Est @ 4.75%

Est @ 3.99%

Est @ 3.46%

Est @ 3.09%

Est @ 2.83%

Present Value ($, Millions) Discounted @ 8.9%

US$164

US$170

US$171

US$169

US$164

US$157

US$150

US$143

US$135

US$128

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.6b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 8.9%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$300m× (1 + 2.2%) ÷ (8.9%– 2.2%) = US$4.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.6b÷ ( 1 + 8.9%)10= US$1.9b

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$3.5b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$48.8, the company appears quite undervalued at a 37% 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
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 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 8.9%, which is based on a levered beta of 1.119. 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.

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 SPX, there are three pertinent aspects you should look at:

  1. Risks: We feel that you should assess the 2 warning signs for SPX we've flagged before making an investment in the company.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SPXC'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 NYSE every day. If you want to find the calculation for other stocks just search here.

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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.