Is Shenandoah Telecommunications Company (NASDAQ:SHEN) trading at a 45% discount?

Does the August stock price for Shenandoah Telecommunications Company (NASDAQ:SHEN) reflect what it’s really worth? Today we are going to estimate the intrinsic value of the stock by taking the expected future cash flows and discounting them to the present value. This will be done using the discounted cash flow (DCF) model. This may sound complicated, but it’s actually quite simple!

We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.

Calculate numbers

We use what is called a 2-step model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less 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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Leveraged FCF ($, millions) -$167.3 million -$103.8 million -$53.1 million $29.5 million $44.6 million $60.9 million $76.9 million $91.4 million $104.0 million $114.6 million
Growth rate estimate Source Analyst x2 Analyst x1 Analyst x1 Analyst x1 Is at 51.33% Is at 36.51% Is at 26.14% Is at 18.88% Is at 13.8% Is at 10.24%
Present value (millions of dollars) discounted at 5.3% -159USD -93.6USD -$45.4 $24.0 $34.4 $44.6 $53.4 $60.3 $65.2 $68.2

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $52 million

The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 5.3%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$115 million × (1 + 1.9%) ÷ (5.3%–1.9%) = US$3.4 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= $3.4 billion ÷ (1 + 5.3%)ten= US$2.0 billion

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is $2.1 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of US$23.3, the company appears to be pretty good value at a 45% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.

NasdaqGS: SHEN Discounted Cash Flow August 26, 2022

Important assumptions

The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Shenandoah Telecommunications 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 takes debt into account. 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 average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

Valuation is only one side of the coin in terms of crafting your investment thesis, and ideally it won’t be the only piece of analysis you look at for a company. The DCF model is not a perfect stock valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. Why is the stock price below intrinsic value? For Shenandoah Telecommunications, you need to explore three fundamentals:

  1. Financial health: Does SHEN have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
  2. Management: Did insiders increase their shares to take advantage of market sentiment about SHEN’s future prospects? View our management and board analysis with insights into CEO compensation and governance factors.
  3. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!

PS. The Simply Wall St app performs a daily updated cash flow assessment for each NASDAQGS stock. If you want to find the calculation for other stocks, search here.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Sean B. Jackson