A Look At The Fair Value Of Aerojet Rocketdyne Holdings, Inc. (NYSE:AJRD)
Today we're doing a simple run of a valuation methodology that will estimate the attractiveness of Aerojet Rocketdyne Holdings, Inc. (NYSE: AJRD) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. This is done according to the DCF model (Discounted Cash Flow). Don't let the jargon put you off, the math behind it is actually pretty simple.
We generally believe that a company's value is the present value of all the cash it will generate in the future. However, a DCF is just one rating metric among many and not without its flaws. If you want to find out more about the intrinsic value, you should read the Simply Wall St analysis model.
Check out our latest analysis for Aerojet Rocketdyne Holdings
Is Aerojet Rocketdyne Holdings fairly valued?
We use what is known as a 2-step model, which simply means that we have two different growth rates for the company's cash flows. Generally, the first stage is higher growth and the second stage is lower growth phase. First, we need to get estimates of the next ten years of cash flow. We use analyst estimates whenever possible. However, if these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to reflect 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. Hence, we need to discount the sum of these future cash flows to get a present value estimate:
10-year free cash flow forecast (FCF)
Leverage FCF ($, million)
$ 223.7 million
$ 223.4 million
$ 209.0 million
$ 208.1 million
$ 208.9 million
$ 210.9 million
$ 213.7 million
$ 217.0 million
$ 220.9 million
$ 225.1 million
Source for growth rate estimation
Est @ -0.41%
Est @ 0.38%
Est @ 0.93%
Est @ 1.32%
Est @ 1.59%
Est @ 1.78%
Est @ 1.91%
Cash Value ($, Million) at a 7.8% discount
US $ 208
US $ 192
US $ 154
US $ 143
US $ 134
US $ 112
US $ 106
("Est" = FCF growth rate, estimated by Simply Wall St)
Present Value of 10 Year Cash Flow (PVCF) = $ 1.5 billion
We now need to calculate the final value that takes into account all future cash flows after this ten year period. The Gordon growth formula is used to calculate the terminal value using a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.8%.
End value (TV) = FCF2030 × (1 + g) ÷ (r - g) = $ 225 million × (1 + 2.2%) ÷ (7.8% - 2.2%) = $ 4.1 billion USD
Present Value of Terminal Value (PVTV) = TV / (1 + r) 10 = $ 4.1 billion ÷ (1 + 7.8%) 10 = $ 1.9 billion
The total value or equity value is then the sum of the present value of the future cash flows, which in this case is $ 3.4 billion. In the final step, we divide the equity value by the number of shares issued. Compared to the current share price of $ 40.5, the company appears at fair value with a discount of 7.9% from the current share price. Ratings, however, are inaccurate instruments, more like a telescope - move a few degrees and land in a different galaxy. Keep that in mind.
We would like to point out that the most important inputs for a discounted cash flow are the discount rate and of course the actual cash flows. Part of the investment is making your own assessment of a company's future performance. So try the calculation yourself and check your own assumptions. Nor does the DCF take into account the possible cyclical nature of an industry or the future capital requirements of a company, so it does not give a complete picture of a company's potential performance. Given that we view Aerojet Rocketdyne Holdings as a potential shareholder, the cost of equity is used as the discount rate and not the cost of capital (or weighted average cost of capital, WACC) responsible for debt. In this calculation we used 7.8% based on a leverage beta of 0.930. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry-standard average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Assessment is only one side of the coin in creating your investment thesis and just one of many factors that you need to evaluate 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 must be made for this stock to be undervalued or overvalued?" If a company is growing at a different rate, or if the cost of equity or the risk-free rate changes dramatically, performance can look very different. For Aerojet Rocketdyne Holdings, we've put together three key aspects that you should evaluate:
Risks: For example, we have identified a warning sign for Aerojet Rocketdyne Holdings that you should be aware of.
Future Outcome: What is AJRD's growth rate compared to its competitors and the broader market? Learn more about analyst consensus number for the years to come by interacting with our free analyst growth expectation chart.
Other Solid Businesses: Low debt, high returns on equity, and good past performance are fundamental to a strong business. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you might not have considered!
PS. The Simply Wall St app performs a discounted cash flow rating for every stock on the NYSE every day. If you want to find the calculation for other stocks, just search here.
This article from Simply Wall St is of a general nature. It is not a recommendation to buy or sell shares and does not take into account your goals or your financial situation. We want to provide you with a long-term, focused analysis based on fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned.
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