In This Article:
Today I will be providing a simple run-through of the discounted cash flows (DCF) method to estimate the attractiveness of Aurizon Holdings Limited (ASX:AZJ) as an investment opportunity. 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 after April 2018 then I highly recommend you check out the latest calculation for Aurizon Holdings here.
Crunching the numbers
I’ve used the 2-stage growth model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To begin, I took the analyst consensus estimates of AZJ’s levered free cash flow (FCF) over the next five years and discounted these figures at the cost of equity of 9.36%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of AU$2.43B. Keen to know how I calculated this value? Read our detailed analysis here.
The graph above shows how AZJ’s top and bottom lines are expected to move going forward, which should give you some color on AZJ’s outlook. Next, I determine the terminal value, which accounts for all the future cash flows after the five years. I think it’s suitable to use the 10-year government bond rate of 2.8% as the steady growth rate, which is rightly below GDP growth, but more towards the conservative side. Discounting the terminal value back five years gives us a present value of AU$5.74B.
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 AU$8.17B. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of A$4.11, which, compared to the current share price of A$4.34, we see that Aurizon Holdings is fair value, maybe slightly overvalued at the time of writing.
Next Steps:
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company.
For AZJ, I’ve put together three fundamental factors you should further examine:
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Financial Health: Does AZJ 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.
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Future Earnings: How does AZJ’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.
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Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of AZJ? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!