Montauk Renewables, Inc. (NASDAQ:MNTK) intrinsic value may be 59% above share price

In this article, we will estimate the intrinsic value of Montauk Renewables, Inc. (NASDAQ:MNTK) by taking the expected future cash flows and discounting them to today’s value. We will do this using 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. If you want to learn more about intrinsic value, you should check out Simply Wall St’s analysis model.

Check out our latest analysis for Montauk Renewables

The model

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, 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 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 more in the early years than in later years.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, the sum of these future cash flows is discounted to today’s value:

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 444 million US dollars

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. For various reasons, a very conservative growth rate is used that cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year “growth” period, we discount future cash flows to today’s value, using a cost of equity of 6.1%.

Final value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = 177 million US dollars × (1 + 2.0%) ÷ (6.1% – 2.0%) = 4.4 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 4.4 billion US dollars ÷ (1 + 6.1%)¹⁰= 2.4 billion US dollars

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total equity value, which in this case is $2.9 billion. In the final step, we divide the equity value by the number of shares outstanding. Relative to the current share price of $12.9, the company appears quite valuable at a 37% discount to the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s better to consider this a rough estimate that isn’t accurate to the last cent.

The assumptions

The above calculation relies heavily on two assumptions. The first is the discount rate and the other is cash flows. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own 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 are considering Montauk Renewables as prospective 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 6.1%, 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 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.

Next Steps:

While a company’s valuation is important, it shouldn’t be the only metric you consider when researching a company. The DCF model is not a perfect tool for stock valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to an undervaluation or overvaluation of the company. For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. What is the reason the stock price is below the intrinsic value? For Montauk Renewables, we’ve compiled three key points for you to consider:

1. Financial health: Does MNTK have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks for key factors such as debt and risk.

2. Future income: How does MNTK’s growth rate compare to its competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.

3. Other high-quality alternatives: Like a good all-rounder? Explore our interactive list of high-quality stocks to get a sense of what else you might be missing out on!

PS The Simply Wall St app runs a discounted cash flow valuation for every stock on the NASDAQCM every day. If you want to find the calculation for other stocks, just search here.

Do you have feedback on this article? Are you concerned about the content? Get in touch directly from us. Alternatively, send an email to editorial-team (at) simplywallst.com.

This Simply Wall St article is of a general nature. We comment 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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