Does Iridium Communications Inc. (NASDAQ:IRDM) September Stock Price Reflect What It’s Really Worth? Today we will estimate the intrinsic value of the stock by estimating the company’s future cash flows and discounting them to their present value. One way to achieve this is by using the discounted cash flow (DCF) model. Believe it or not, it’s not too difficult to follow as you will see from our example!
Companies can be valued in many ways, so we would like to point out that a DCF is not perfect for every situation. For those who are fond of stock analysis, Simply Wall St’s analysis model might be of interest to you here.
Check out our latest analysis for Iridium Communications
What is the estimated value?
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first phase is generally a higher growth phase that levels off towards the terminal value captured in the second phase of ‘steady growth’. First, we need to get estimates of cash flows for the next ten years. Where possible we use analyst estimates, but when these are not available we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We expect companies with declining free cash flow to slow their rate of contraction and companies with growing free cash flow to slow their growth rate over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.
A DCF is all about the idea that a dollar in the future is worth less than a dollar today, and so the sum of those future cash flows is then discounted to today’s value:
10-year free cash flow (FCF) estimate.
|Leveraged FCF ($, million)||$306.4 million||$348.6 million||$372.5 million||$392.5 million||$409.6 million||$424.4 million||$437.7 million||$449.8 million||$461.1 million||$471.9 million|
|Source of growth rate estimate||Analyst x2||Analyst x1||Estimated at 6.85%||Estimated @ 5.38%||Estimated @ 4.35%||Estimated @ 3.62%||Estimated @ 3.12%||Estimated at 2.77%||Estimated @ 2.52%||Estimated @ 2.34%|
|Present Value ($, millions) Discounted @ 5.3%||$291||$314||$319||$319||$316||$311||$304||$297||$289||$281|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = $3.0 billion
The second stage is also known as the terminal value, this is the company’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 10-year government bond yield of 1.9%. We discount the final cash flows to today’s value using a cost of equity rate of 5.3%.
final value (TV)= FCF2032 × (1 + g) ÷ (r – g) = $472 million × (1 + 1.9%) ÷ (5.3% – 1.9%) = $14 billion
Present value of terminal value (PVTV)= TV / (1 + r)10= $14 billion ÷ (1 + 5.3%)10= $8.4 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $11 billion. In the final step, we divide the equity value by the number of outstanding shares. Compared to the current share price of $45.3, the company appears fairly undervalued at a discount of 50% to the current share price. The assumptions in each calculation have a big impact on the score, so it’s better to take this as a rough estimate, not accurate to the last penny.
Now the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You do not have to agree with these inputs, I recommend repeating and playing with the calculations yourself. The DCF also does not take into account the potential cyclicality of an industry or a company’s future capital needs, so it does not provide a complete picture of a company’s potential performance. Because we view Iridium Communications as a potential shareholder, 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 used 5.3% which is based on a leveraged beta of 0.800. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the industry average of global peers, with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable business.
While a company’s valuation is important, it shouldn’t be the only metric you consider when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you would apply different cases and assumptions and see how they would affect the company’s valuation. For example, slightly adjusting the growth rate of the terminal value can dramatically change the overall result. Can we find out why the company is trading at a discount to intrinsic value? For Iridium Communications, we have identified three fundamental factors for you to investigate:
- risks: We think you should judge that 2 warning signs for Iridium Communications (1 makes us a little uncomfortable!) We reached out before making an investment in the company.
- management: Have insiders stocked up to take advantage of market sentiment on IRDM’s future prospects? Check out our management and board analysis for insights into CEO pay and governance factors.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of quality stocks to get an idea of what else you might be missing!
hp Simply Wall St updates its DCF calculation for each American stock daily. So if you want to find the intrinsic value of another stock, just search here.
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This Simply Wall St article is of a general nature. We provide comments based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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