Peter Warren Automotive Holdings Limited's (ASX:PWR) Intrinsic Value Is Potentially 82% Above Its Share Price

Key Insights

• The projected fair value for Peter Warren Automotive Holdings is AU$3.93 based on 2 Stage Free Cash Flow to Equity

• Peter Warren Automotive Holdings' AU$2.16 share price signals that it might be 45% undervalued

• Analyst price target for PWR is AU$3.34 which is 15% below our fair value estimate

In this article we are going to estimate the intrinsic value of Peter Warren Automotive Holdings Limited (ASX:PWR) 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. It may sound complicated, but actually it is quite simple!

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 Peter Warren Automotive Holdings

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. To begin with, we have to get estimates of 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (A$, Millions)	AU$42.4m	AU$53.2m	AU$57.1m	AU$60.1m	AU$62.6m	AU$64.9m	AU$67.0m	AU$68.8m	AU$70.6m	AU$72.4m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x4	Est @ 5.21%	Est @ 4.27%	Est @ 3.61%	Est @ 3.15%	Est @ 2.83%	Est @ 2.61%	Est @ 2.45%
Present Value (A$, Millions) Discounted @ 11%	AU$38.3	AU$43.5	AU$42.2	AU$40.2	AU$37.9	AU$35.5	AU$33.1	AU$30.8	AU$28.6	AU$26.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$357m

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 (2.1%) 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 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = AU$72m× (1 + 2.1%) ÷ (11%– 2.1%) = AU$870m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= AU$870m÷ ( 1 + 11%)¹⁰= AU$319m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$675m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$2.2, the company appears quite good value at a 45% 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

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Peter Warren Automotive 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 11%, which is based on a levered beta of 1.698. 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 Peter Warren Automotive Holdings

Strength

• Debt is well covered by earnings and cashflows.

• Dividends are covered by earnings and cash flows.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

• Earnings declined over the past year.

Opportunity

• Annual revenue is forecast to grow faster than the Australian market.

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

Threat

• Annual earnings are forecast to decline for the next 3 years.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. Can we work out why the company is trading at a discount to intrinsic value? For Peter Warren Automotive Holdings, we've compiled three additional items you should further examine:

1. Risks: To that end, you should learn about the 3 warning signs we've spotted with Peter Warren Automotive Holdings (including 1 which is potentially serious) .

2. Future Earnings: How does PWR'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 Australian 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.