Tutor Perini Corporation (NYSE:TPC) Shares Could Be 24% Below Their Intrinsic Value Estimate

By
Simply Wall St
Published
December 02, 2021

In this article we are going to estimate the intrinsic value of Tutor Perini Corporation (NYSE:TPC) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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. 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.

See our latest analysis for Tutor Perini

The method

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) forecast

 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Levered FCF (\$, Millions) US\$92.0m US\$85.0m US\$81.2m US\$79.1m US\$78.1m US\$77.9m US\$78.2m US\$78.9m US\$79.9m US\$81.0m Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ -4.51% Est @ -2.57% Est @ -1.21% Est @ -0.26% Est @ 0.41% Est @ 0.87% Est @ 1.2% Est @ 1.43% Present Value (\$, Millions) Discounted @ 10% US\$83.3 US\$69.7 US\$60.2 US\$53.1 US\$47.5 US\$42.9 US\$39.0 US\$35.6 US\$32.6 US\$30.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US\$494m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US\$81m× (1 + 2.0%) ÷ (10%– 2.0%) = US\$973m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US\$973m÷ ( 1 + 10%)10= US\$360m

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\$854m. 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\$12.7, the company appears a touch undervalued at a 24% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Tutor Perini 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 10%, which is based on a levered beta of 1.939. 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.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Tutor Perini, we've compiled three essential elements you should explore:

1. Risks: We feel that you should assess the 2 warning signs for Tutor Perini (1 is potentially serious!) we've flagged before making an investment in the company.
2. Future Earnings: How does TPC's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
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.

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