An Intrinsic Calculation For Orion Group Holdings, Inc. (NYSE:ORN) Suggests It's 43% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Orion Group Holdings fair value estimate is US$8.65
• Current share price of US$4.93 suggests Orion Group Holdings is potentially 43% undervalued
• Our fair value estimate is 28% higher than Orion Group Holdings' analyst price target of US$6.75

Does the November share price for Orion Group Holdings, Inc. (NYSE:ORN) 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. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 Orion Group Holdings

Crunching The Numbers

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 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$4.08m	US$6.30m	US$13.6m	US$17.2m	US$19.9m	US$22.2m	US$24.2m	US$25.9m	US$27.3m	US$28.5m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Analyst x1	Est @ 15.73%	Est @ 11.68%	Est @ 8.84%	Est @ 6.85%	Est @ 5.46%	Est @ 4.49%
Present Value ($, Millions) Discounted @ 9.2%	US$3.7	US$5.3	US$10.4	US$12.1	US$12.8	US$13.1	US$13.1	US$12.8	US$12.4	US$11.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$108m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 9.2%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$28m× (1 + 2.2%) ÷ (9.2%– 2.2%) = US$418m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$418m÷ ( 1 + 9.2%)¹⁰= US$173m

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$281m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$4.9, the company appears quite good value at a 43% 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.

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. 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 Orion Group 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 9.2%, which is based on a levered beta of 1.394. 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 Orion Group Holdings

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. 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. Why is the intrinsic value higher than the current share price? For Orion Group Holdings, we've compiled three relevant factors you should further research:

1. Risks: For instance, we've identified 3 warning signs for Orion Group Holdings that you should be aware of.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ORN's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE 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. 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.