Estimating The Fair Value Of Cleanaway Waste Management Limited (ASX:CWY)

By
Simply Wall St
Published
October 30, 2020
ASX:CWY

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Cleanaway Waste Management Limited (ASX:CWY) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Cleanaway Waste Management

Is Cleanaway Waste Management fairly valued?

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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (A$, Millions) AU$176.9m AU$187.8m AU$204.8m AU$224.5m AU$234.5m AU$242.7m AU$250.2m AU$257.4m AU$264.3m AU$271.0m
Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x3 Analyst x2 Analyst x2 Est @ 3.49% Est @ 3.12% Est @ 2.86% Est @ 2.68% Est @ 2.55%
Present Value (A$, Millions) Discounted @ 8.1% AU$164 AU$161 AU$162 AU$164 AU$159 AU$152 AU$145 AU$138 AU$131 AU$124

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.5b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 8.1%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = AU$271m× (1 + 2.3%) ÷ (8.1%– 2.3%) = AU$4.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$4.8b÷ ( 1 + 8.1%)10= AU$2.2b

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$3.7b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of AU$2.1, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
ASX:CWY Discounted Cash Flow October 30th 2020

The 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 Cleanaway Waste Management 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 8.1%, which is based on a levered beta of 0.971. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Cleanaway Waste Management, we've compiled three essential items you should assess:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Cleanaway Waste Management , and understanding them should be part of your investment process.
  2. Future Earnings: How does CWY'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. 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.

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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.
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