Is AECOM (NYSE:ACM) Trading At A 26% Discount?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, AECOM fair value estimate is US$108
• Current share price of US$79.58 suggests AECOM is potentially 26% undervalued
• Our fair value estimate is 12% higher than AECOM's analyst price target of US$96.03

In this article we are going to estimate the intrinsic value of AECOM (NYSE:ACM) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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

View our latest analysis for AECOM

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$616.4m	US$662.0m	US$739.0m	US$816.0m	US$873.3m	US$921.9m	US$963.8m	US$1.00b	US$1.03b	US$1.06b
Growth Rate Estimate Source	Analyst x2	Analyst x1	Analyst x1	Analyst x1	Est @ 7.03%	Est @ 5.56%	Est @ 4.54%	Est @ 3.82%	Est @ 3.32%	Est @ 2.97%
Present Value ($, Millions) Discounted @ 7.7%	US$572	US$570	US$591	US$606	US$602	US$590	US$572	US$551	US$529	US$505

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$5.7b

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 (2.2%) 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 7.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$1.1b× (1 + 2.2%) ÷ (7.7%– 2.2%) = US$19b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$19b÷ ( 1 + 7.7%)¹⁰= US$9.2b

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$15b. 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$79.6, the company appears a touch undervalued at a 26% 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.

Important 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 AECOM 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 7.7%, which is based on a levered beta of 1.117. 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 AECOM

Moving On:

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. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For AECOM, we've put together three additional elements you should assess:

1. Risks: You should be aware of the 1 warning sign for AECOM we've uncovered before considering an investment in the company.
2. Future Earnings: How does ACM'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 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. 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.