Estimating The Fair Value Of Werner Enterprises, Inc. (NASDAQ:WERN)

Key Insights

• The projected fair value for Werner Enterprises is US$28.93 based on 2 Stage Free Cash Flow to Equity
• Werner Enterprises' US$27.66 share price indicates it is trading at similar levels as its fair value estimate
• Our fair value estimate is 8.0% lower than Werner Enterprises' analyst price target of US$31.43

Today we will run through one way of estimating the intrinsic value of Werner Enterprises, Inc. (NASDAQ:WERN) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Our free stock report includes 4 warning signs investors should be aware of before investing in Werner Enterprises. Read for free now.

Step By Step Through The Calculation

We're 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 a stable growth rate. 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$98.3m	US$99.6m	US$101.3m	US$103.3m	US$105.6m	US$108.1m	US$110.8m	US$113.7m	US$116.6m	US$119.7m
Growth Rate Estimate Source	Analyst x3	Analyst x4	Est @ 1.67%	Est @ 1.99%	Est @ 2.22%	Est @ 2.38%	Est @ 2.49%	Est @ 2.57%	Est @ 2.62%	Est @ 2.66%
Present Value ($, Millions) Discounted @ 8.0%	US$91.0	US$85.4	US$80.4	US$75.9	US$71.8	US$68.1	US$64.6	US$61.3	US$58.2	US$55.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$712m

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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.0%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$120m× (1 + 2.8%) ÷ (8.0%– 2.8%) = US$2.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$2.3b÷ ( 1 + 8.0%)¹⁰= US$1.1b

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$1.8b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$27.7, the company appears about fair value at a 4.4% 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. 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 Werner Enterprises 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 8.0%, which is based on a levered beta of 1.217. 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.

View our latest analysis for Werner Enterprises

SWOT Analysis for Werner Enterprises

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for 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. For Werner Enterprises, we've put together three essential factors you should explore:

1. Risks: Case in point, we've spotted 4 warning signs for Werner Enterprises you should be aware of, and 2 of them are significant.
2. Future Earnings: How does WERN'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks 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.