- The projected fair value for Williams Companies is US$27.97 based on 2 Stage Free Cash Flow to Equity
- Williams Companies’ US$28.30 share price indicates it is trading at similar levels as its fair value estimate
- Analyst price target for WMB is US$37.06, which is 33% above our fair value estimate
How far off is The Williams Companies, Inc. (NYSE:WMB) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today’s value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Williams Companies
What’s The Estimated Valuation?
We’re using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:
10-year free cash flow (FCF) forecast
|Levered FCF ($, Millions)||US$2.54b||US$2.76b||US$2.91b||US$3.15b||US$3.36b||US$3.51b||US$3.65b||US$3.77b||US$3.88b||US$3.98b|
|Growth Rate Estimate Source||Analyst x4||Analyst x5||Analyst x2||Analyst x2||Analyst x2||Est @ 4.62%||Est @ 3.85%||Est @ 3.32%||Est @ 2.94%||Est @ 2.68%|
|Present Value ($, Millions) Discounted @ 11%||US$2.3k||US$2.2k||US$2.1k||US$2.1k||US$2.0k||US$1.9k||US$1.7k||US$1.6k||US$1.5k||US$1.4k|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$19b
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 2.1%. We discount the terminal cash flows to today’s value at a cost of equity of 11%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$4.0b× (1 + 2.1%) ÷ (11%– 2.1%) = US$44b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$44b÷ ( 1 + 11%)10= US$15b
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$34b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$28.3, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company’s future performance, so try the calculation yourself and check your own assumptions. 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 Williams Companies 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 11%, which is based on a levered beta of 1.539. 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.
SWOT Analysis for Williams Companies
- Earnings growth over the past year exceeded its 5-year average.
- Debt is well covered by cash flow.
- Dividend is in the top 25% of dividend payers in the market.
- Earnings growth over the past year underperformed the Oil and Gas industry.
- Interest payments on debt are not well covered.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow for the next 3 years.
- Dividends are not covered by earnings.
- Annual earnings are forecast to grow slower than the American market.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching 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 need to be true for this stock to be under/overvalued?” For example, changes in the company’s cost of equity or the risk free rate can significantly impact the valuation. For Williams Companies, we’ve compiled three fundamental elements you should further research:
- Risks: You should be aware of the 3 warning signs for Williams Companies (1 shouldn’t be ignored!) we’ve uncovered before considering an investment in the company.
- Future Earnings: How does WMB’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: 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 NYSE every day. If you want to find the calculation for other stocks just search here.
Valuation is complex, but we’re helping make it simple.
Find out whether Williams Companies is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.