Calculating The Intrinsic Value Of Waste Connections, Inc. (NYSE:WCN)

Key Insights

• Waste Connections' estimated fair value is US$179 based on 2 Stage Free Cash Flow to Equity
• With US$165 share price, Waste Connections appears to be trading close to its estimated fair value
• Our fair value estimate is 1.1% lower than Waste Connections' analyst price target of US$181

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Waste Connections, Inc. (NYSE:WCN) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 Waste Connections

Is Waste Connections Fairly Valued?

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.

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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$1.19b	US$1.54b	US$1.82b	US$1.99b	US$2.16b	US$2.28b	US$2.38b	US$2.48b	US$2.57b	US$2.64b
Growth Rate Estimate Source	Analyst x13	Analyst x14	Analyst x4	Analyst x3	Analyst x3	Est @ 5.69%	Est @ 4.67%	Est @ 3.96%	Est @ 3.46%	Est @ 3.11%
Present Value ($, Millions) Discounted @ 6.7%	US$1.1k	US$1.3k	US$1.5k	US$1.5k	US$1.6k	US$1.5k	US$1.5k	US$1.5k	US$1.4k	US$1.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$14b

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 (2.3%) 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 6.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$2.6b× (1 + 2.3%) ÷ (6.7%– 2.3%) = US$61b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$61b÷ ( 1 + 6.7%)¹⁰= US$32b

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$46b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$165, the company appears about fair value at a 7.8% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Waste Connections 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 6.7%, which is based on a levered beta of 0.964. 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 Waste Connections

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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. For Waste Connections, there are three further items you should further research:

1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Waste Connections .
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for WCN'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.