Estimating The Intrinsic Value Of Orion Group Holdings, Inc. (NYSE:ORN)

Key Insights

• Orion Group Holdings' estimated fair value is US$10.92 based on 2 Stage Free Cash Flow to Equity
• With US$9.63 share price, Orion Group Holdings appears to be trading close to its estimated fair value
• Our fair value estimate is 10% lower than Orion Group Holdings' analyst price target of US$12.17

In this article we are going to estimate the intrinsic value of Orion Group Holdings, Inc. (NYSE:ORN) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

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 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, 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$8.67m	US$11.7m	US$14.7m	US$17.4m	US$19.8m	US$21.8m	US$23.5m	US$25.0m	US$26.3m	US$27.4m
Growth Rate Estimate Source	Analyst x2	Est @ 35.24%	Est @ 25.38%	Est @ 18.48%	Est @ 13.65%	Est @ 10.27%	Est @ 7.90%	Est @ 6.25%	Est @ 5.09%	Est @ 4.27%
Present Value ($, Millions) Discounted @ 7.9%	US$8.0	US$10.1	US$11.7	US$12.8	US$13.5	US$13.8	US$13.8	US$13.6	US$13.2	US$12.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$123m

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. 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 (2.4%) 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 7.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$27m× (1 + 2.4%) ÷ (7.9%– 2.4%) = US$505m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$505m÷ ( 1 + 7.9%)¹⁰= US$235m

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$359m. 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$9.6, the company appears about fair value at a 12% 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 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 7.9%, which is based on a levered beta of 1.208. 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

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Orion Group Holdings, we've put together three further elements you should further examine:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Orion Group Holdings , and understanding them should be part of your investment process.
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 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com