Stock Analysis

Parsons Corporation (NYSE:PSN) Shares Could Be 50% Below Their Intrinsic Value Estimate

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NYSE:PSN
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Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Parsons Corporation (NYSE:PSN) 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Parsons

What's The Estimated Valuation?

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.

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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$256.5m US$281.5m US$299.9m US$315.4m US$328.6m US$340.2m US$350.6m US$360.1m US$369.0m US$377.6m
Growth Rate Estimate Source Analyst x3 Analyst x3 Est @ 6.55% Est @ 5.16% Est @ 4.2% Est @ 3.52% Est @ 3.05% Est @ 2.71% Est @ 2.48% Est @ 2.32%
Present Value ($, Millions) Discounted @ 5.6% US$243 US$252 US$254 US$253 US$250 US$245 US$239 US$232 US$225 US$218

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.4b

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 (1.9%) 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 5.6%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$378m× (1 + 1.9%) ÷ (5.6%– 1.9%) = US$10b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$10b÷ ( 1 + 5.6%)10= US$6.0b

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$8.4b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$40.7, the company appears quite good value at a 50% 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.

dcf
NYSE:PSN Discounted Cash Flow October 4th 2022

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 Parsons 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 5.6%, which is based on a levered beta of 0.873. 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.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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. Can we work out why the company is trading at a discount to intrinsic value? For Parsons, we've put together three important elements you should explore:

  1. Financial Health: Does PSN have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for PSN'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. 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.

Valuation is complex, but we're helping make it simple.

Find out whether Parsons is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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About NYSE:PSN

Parsons

Parsons Corporation provides integrated solutions and services in the defense, intelligence, and critical infrastructure markets in North America, the Middle East, and internationally.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation2
Future Growth3
Past Performance4
Financial Health5
Dividends0

Read more about these checks in the individual report sections or in our analysis model.

Excellent balance sheet with proven track record.