Are Casella Waste Systems, Inc. (NASDAQ:CWST) Investors Paying Above The Intrinsic Value?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Casella Waste Systems fair value estimate is US$67.75

• Current share price of US$89.28 suggests Casella Waste Systems is potentially 32% overvalued

• Our fair value estimate is 32% lower than Casella Waste Systems' analyst price target of US$99.00

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Casella Waste Systems, Inc. (NASDAQ:CWST) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Casella Waste Systems

Step By Step Through The Calculation

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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$143.2m	US$158.8m	US$170.4m	US$180.4m	US$189.0m	US$196.6m	US$203.5m	US$209.9m	US$215.9m	US$221.8m
Growth Rate Estimate Source	Analyst x4	Analyst x3	Est @ 7.35%	Est @ 5.83%	Est @ 4.77%	Est @ 4.03%	Est @ 3.51%	Est @ 3.14%	Est @ 2.89%	Est @ 2.71%
Present Value ($, Millions) Discounted @ 6.8%	US$134	US$139	US$140	US$139	US$136	US$133	US$129	US$124	US$120	US$115

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.3b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.3%) 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 6.8%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$222m× (1 + 2.3%) ÷ (6.8%– 2.3%) = US$5.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$5.1b÷ ( 1 + 6.8%)¹⁰= US$2.6b

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$3.9b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$89.3, the company appears reasonably expensive at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Casella Waste Systems 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 6.8%, which is based on a levered beta of 0.977. 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 Casella Waste Systems

Strength

• Debt is well covered by earnings and cashflows.

Weakness

• Earnings declined over the past year.

• Expensive based on P/E ratio and estimated fair value.

• Shareholders have been diluted in the past year.

Opportunity

• Annual earnings are forecast to grow faster than the American market.

Threat

• Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value lower than the current share price? For Casella Waste Systems, we've compiled three fundamental factors you should look at:

1. Risks: For example, we've discovered 4 warning signs for Casella Waste Systems that you should be aware of before investing here.

2. Future Earnings: How does CWST'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.

3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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

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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.