Space tourism stocks are not for the faint of heart. After another parabolic run-up in June, Virgin Galactic Holdings, Inc. ( NYSE:SPCE ) is now free-falling.
W e will run through one way of estimating the intrinsic value of the stock. We will examine the Discounted Cash Flow (DCF) model for the stock, as a way to gauge where this drop might stop before the next round on the market roller-coaster.
Q2 Earnings report
- Q2 GAAP EPS: US$-0.39 (miss by US$0.06)
- Revenue : US$ 0.57m
- Net loss: US$94m
- Cash reserves: US$ 552m
Morgan Stanley cut the rating to Underweight from Equal-weight. They quoted a prolonged period of no flights, as the company won't conduct any until the summer of 2022. Investment bank stuck to the long-term target of US$25.
Even with the ticket prices now beginning at US$450,000 (the original price was US$250,000 ), commercial operations will have to wait until at least one more test flight, along with the overhaul of the mothership Eve, is completed. At this point, there are just too many uncertainties and potential postponements to be sure when the stock will finally get to breakeven.
Companies can be valued in many ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, look at the Simply Wall St analysis model .
We're using the 2-stage growth model, which means we take two stages of the company's growth. In the initial period, the company may have a higher growth rate, and the second stage is usually assumed to have a stable growth rate.
For a start, we have to get estimates of the next ten years of cash flows.Where possible, we use analyst estimates, but when these aren't available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value.
We assume companies with shrinking free cash flow will slow their rate of shrinkage and that companies with growing free cash flow will see their growth rate slow over this period. We do this to reflect that growth tends to slow more in the early years than in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today,so we discount the value of these future cash flows to their estimated worth in today's dollars:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||-US$242.7m||-US$155.7m||-US$99.1m||US$66.3m||US$99.1m||US$134.0m||US$167.8m||US$198.4m||US$225.0m||US$247.4m|
|Growth Rate Estimate Source||Analyst x4||Analyst x4||Analyst x3||Analyst x3||Est @ 49.42%||Est @ 35.19%||Est @ 25.23%||Est @ 18.26%||Est @ 13.38%||Est @ 9.96%|
|Present Value ($, Millions) Discounted @ 6.5%||-US$228||-US$137||-US$82.0||US$51.5||US$72.3||US$91.8||US$108||US$120||US$128||US$132|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$255m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after these ten years.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 2.0%. We discount the terminal cash flows to today's value at the cost of equity of 6.5%.
Terminal Value (TV) = FCF 2031 × (1 + g) ÷ (r + g) = US$247m× (1 + 2.0%) ÷ (6.5% - 2.0%) = US$5.6b
Present Value of Terminal Value (PVTV) = TV / (1 + r) 10 = US$5.6b÷ ( 1 + 6.5%) 10 = US$3.0b
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$3.2b.To get the intrinsic value per share, we divide this by the total number of shares outstanding.Relative to the current share price of US$27.4, the company appears factoring in a lot of growth,and so the big question becomes: why is this stock so pricey?The assumptions in any calculation significantly impact the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
We would point out that the most critical inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows.Part of investing is coming up with your evaluation of a company's future performance, so try the calculation yourself and check your 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 complete picture of its potential performance.Given that we are looking at Virgin Galactic Holdings as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or a weighted average cost of capital, WACC), which accounts for debt.
We've used 6.5% in this calculation, which is based on a levered beta of 0.958. 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, a reasonable range for a stable business.
Valuation is only one side of the coin in building your investment thesis, and it ideally won't be the only piece of analysis you scrutinize for a company.DCF models are not the be-all and end-all of investment valuation.Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation.For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result.Why is the intrinsic value lower than the current share price?For Virgin Galactic Holdings, we've put together three additional factors you should look at:
- Risks : We feel that you should assess the 4 warning signs for Virgin Galactic Holdings (1 is a bit unpleasant!) we've flagged before making an investment in the company.
- Future Earnings : How does SPCE's growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart .
- 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 .
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. 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.