Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of GTT Communications Inc (NYSE:GTT) as an investment opportunity by estimating the company’s future cash flows and discounting them to their present value. I will use the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not August 2018 then I highly recommend you check out the latest calculation for GTT Communications by following the link below.
Is GTT fairly valued?
I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
|Levered FCF ($, Millions)||$76.57||$192.87||$278.15||$374.96||$442.76|
|Source||Analyst x4||Analyst x5||Analyst x2||Analyst x1||Analyst x1|
|Present Value Discounted @ 15.19%||$66.47||$145.37||$182.00||$213.00||$218.36|
Present Value of 5-year Cash Flow (PVCF)= US$825.21m
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 15.2%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$442.76m × (1 + 2.9%) ÷ (15.2% – 2.9%) = US$3.73b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$3.73b ÷ ( 1 + 15.2%)5 = US$1.84b
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$2.66b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $48.81. Relative to the current share price of $44.45, the stock is about right, perhaps slightly undervalued at a 8.94% discount to what it is available for right now.
I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at GTT Communications as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 15.2%, which is based on a levered beta of 1.736. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. For GTT, I’ve compiled three pertinent aspects you should further research:
- Financial Health: Does GTT 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.
- Future Earnings: How does GTT’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of GTT? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
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The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.