Babcock & Wilcox Enterprises, Inc. (NYSE:BW) Shares Could Be 34% Below Their Intrinsic Value Estimate

Key Insights

• Babcock & Wilcox Enterprises' estimated fair value is US$8.80 based on 2 Stage Free Cash Flow to Equity
• Babcock & Wilcox Enterprises is estimated to be 34% undervalued based on current share price of US$5.82
• Analyst price target for BW is US$9.00, which is 2.3% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Babcock & Wilcox Enterprises, Inc. (NYSE:BW) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

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.

View our latest analysis for Babcock & Wilcox Enterprises

What's The Estimated Valuation?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

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) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$23.5m	US$37.3m	US$53.6m	US$66.4m	US$77.8m	US$87.7m	US$96.1m	US$103.1m	US$109.1m	US$114.1m
Growth Rate Estimate Source	Analyst x3	Analyst x4	Analyst x2	Est @ 23.79%	Est @ 17.29%	Est @ 12.73%	Est @ 9.55%	Est @ 7.32%	Est @ 5.75%	Est @ 4.66%
Present Value ($, Millions) Discounted @ 12%	US$21.0	US$29.8	US$38.4	US$42.5	US$44.6	US$45.0	US$44.1	US$42.3	US$40.0	US$37.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$385m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$114m× (1 + 2.1%) ÷ (12%– 2.1%) = US$1.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.2b÷ ( 1 + 12%)¹⁰= US$396m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$781m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$5.8, the company appears quite undervalued at a 34% 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.

Important 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 Babcock & Wilcox Enterprises 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 12%, which is based on a levered beta of 1.628. 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 Babcock & Wilcox Enterprises

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Babcock & Wilcox Enterprises, there are three pertinent aspects you should assess:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Babcock & Wilcox Enterprises .
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for BW's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.