A Look At The Fair Value Of RGC Resources, Inc. (NASDAQ:RGCO)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, RGC Resources fair value estimate is US$24.11

• With US$19.80 share price, RGC Resources appears to be trading close to its estimated fair value

• Industry average discount to fair value of 14% suggests RGC Resources' peers are currently trading at a lower discount

Does the April share price for RGC Resources, Inc. (NASDAQ:RGCO) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for RGC Resources

The Model

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$2.88m	US$4.26m	US$5.72m	US$7.12m	US$8.40m	US$9.51m	US$10.5m	US$11.2m	US$11.9m	US$12.5m
Growth Rate Estimate Source	Est @ 67.26%	Est @ 47.77%	Est @ 34.13%	Est @ 24.58%	Est @ 17.89%	Est @ 13.21%	Est @ 9.93%	Est @ 7.64%	Est @ 6.04%	Est @ 4.91%
Present Value ($, Millions) Discounted @ 6.1%	US$2.7	US$3.8	US$4.8	US$5.6	US$6.3	US$6.7	US$6.9	US$7.0	US$7.0	US$6.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$58m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (2.3%) 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 6.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$13m× (1 + 2.3%) ÷ (6.1%– 2.3%) = US$338m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$338m÷ ( 1 + 6.1%)¹⁰= US$187m

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$245m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$19.8, the company appears about fair value at a 18% 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

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 RGC Resources 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 6.1%, which is based on a levered beta of 0.824. 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 RGC Resources

Strength

• Debt is well covered by earnings.

Weakness

• Dividend is low compared to the top 25% of dividend payers in the Gas Utilities market.

• Shareholders have been diluted in the past year.

Opportunity

• Current share price is below our estimate of fair value.

Threat

• Debt is not well covered by operating cash flow.

• Dividends are not covered by cash flow.

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. It's not possible to obtain a foolproof valuation with a DCF model. 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. For RGC Resources, we've put together three important items you should further examine:

1. Risks: We feel that you should assess the 4 warning signs for RGC Resources (2 don't sit too well with us!) we've flagged before making an investment in the company.

2. Future Earnings: How does RGCO'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.

3. 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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.