CECO Environmental Corp. (NASDAQ:CECO) shares could be 50% below their estimated intrinsic value

Key findings

• The estimated fair value of CECO Environmental is $49.89 based on 2-step Free Cash Flow to Equity
• CECO Environmental is estimated to be undervalued by 50% based on the current share price of $24.95.
• Our fair value estimate is 80% above CECO Environmental’s analyst price target of $27.67.

In this article, we will estimate the intrinsic value of CECO Environmental Corp. (NASDAQ:CECO) by taking the company’s projected future cash flows and discounting them to today’s value. To do this, we will use the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too difficult to follow, as you’ll see from our example!

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one of them. For those who enjoy stock analysis, the analysis model presented here by Simply Wall St might be of interest.

Check out our latest analysis for CECO Environmental

The model

We use the 2-stage growth model, which simply means that we consider two stages of company growth. In the early stage, the company might have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. First, we need to estimate the next ten years’ worth of cash flows. Where possible, we use analyst estimates, but when 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 shrinkage, and that companies with growing free cash flow will 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. Therefore, we need to discount the sum of these future cash flows to arrive at an estimate of present value:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 531 million US dollars

The second phase is also called the terminal value, which is the company’s cash flow after the first phase. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.4%. We discount the terminal cash flows to today’s value at a cost of equity of 6.9%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = 104 million US dollars × (1 + 2.4%) ÷ (6.9% – 2.4%) = 2.4 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 2.4 billion US dollars ÷ (1 + 6.9%)¹⁰= 1.2 billion US dollars

The total value or equity value is then the sum of the present value of future cash flows, which in this case is $1.7 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of $25.00, the company appears quite undervalued at a 50% discount to the current share price. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep this in mind.

The assumptions

The above calculation relies heavily on two assumptions. The first is the discount rate and the other is the cash flows. If you disagree with these results, try the calculation yourself and play with the assumptions. DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we consider CECO Environmental 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 6.9% which is based on a leveraged beta of 0.984. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of between 0.8 and 2.0 which is a reasonable range for a stable company.

SWOT Analysis for CECO Environmental

Next Steps:

While a company’s valuation is important, it is only one of many factors you need to evaluate a company. It is not possible to get a foolproof valuation using a DCF model. A better way would be to apply different cases and assumptions and see how they would affect the company’s valuation. For example, if the growth rate of the terminal value is adjusted slightly, it can change the overall result dramatically. Why is the intrinsic value higher than the current share price? For CECO Environmental, we have compiled three other elements that you should examine in more detail:

1. Risks: For this purpose, you should consult the 2 warning signs we discovered it at CECO Environmental.
2. management:Have insiders increased their shares to capitalize on market sentiment regarding CECO’s future prospects? Read our management and board analysis for insights into CEO compensation and governance factors.
3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock daily, so if you want to find out the intrinsic value of another stock, just search here.

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This Simply Wall St article is of a general nature. We comment based solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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