In this article we are going to estimate the intrinsic value of Wyndham Hotels & Resorts, Inc. (NYSE:WH) by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
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.
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
|Levered FCF ($, Millions)||US$305.0m||US$338.6m||US$411.0m||US$457.0m||US$490.9m||US$519.4m||US$543.7m||US$564.9m||US$583.7m||US$600.9m|
|Growth Rate Estimate Source||Analyst x3||Analyst x3||Analyst x1||Analyst x1||Est @ 7.42%||Est @ 5.81%||Est @ 4.68%||Est @ 3.89%||Est @ 3.33%||Est @ 2.94%|
|Present Value ($, Millions) Discounted @ 9.4%||US$279||US$283||US$314||US$319||US$314||US$304||US$291||US$276||US$261||US$246|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.9b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 9.4%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$601m× (1 + 2.0%) ÷ (9.4%– 2.0%) = US$8.4b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$8.4b÷ ( 1 + 9.4%)10= US$3.4b
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$6.3b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$59.8, 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.
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 Wyndham Hotels & Resorts 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 9.4%, which is based on a levered beta of 1.400. 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.
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Wyndham Hotels & Resorts, there are three pertinent aspects you should explore:
- Risks: For example, we've discovered 2 warning signs for Wyndham Hotels & Resorts (1 is a bit concerning!) that you should be aware of before investing here.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for WH's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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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