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Estimating The Fair Value Of Alaska Air Group, Inc. (NYSE:ALK)

Key Insights

  • Alaska Air Group's estimated fair value is US$37.45 based on 2 Stage Free Cash Flow to Equity

  • Alaska Air Group's US$43.75 share price indicates it is trading at similar levels as its fair value estimate

  • Our fair value estimate is 33% lower than Alaska Air Group's analyst price target of US$55.73

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Alaska Air Group, Inc. (NYSE:ALK) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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Check out our latest analysis for Alaska Air Group

Is Alaska Air Group Fairly Valued?

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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

-US$255.0m

US$205.0m

US$241.1m

US$272.5m

US$299.3m

US$322.0m

US$341.4m

US$358.3m

US$373.2m

US$386.8m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Est @ 17.59%

Est @ 13.03%

Est @ 9.83%

Est @ 7.60%

Est @ 6.03%

Est @ 4.94%

Est @ 4.17%

Est @ 3.63%

Present Value ($, Millions) Discounted @ 8.0%

-US$236

US$176

US$191

US$200

US$204

US$203

US$199

US$193

US$187

US$179

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.5b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.4%) 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 8.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$387m× (1 + 2.4%) ÷ (8.0%– 2.4%) = US$7.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$7.0b÷ ( 1 + 8.0%)10= US$3.3b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$4.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$43.8, 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.

dcf
dcf

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Alaska Air Group 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 8.0%, which is based on a levered beta of 1.224. 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 Alaska Air Group

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is not viewed as a risk.

Weakness

  • No major weaknesses identified for ALK.

Opportunity

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

  • Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

  • Annual revenue is forecast to grow slower than the American market.

Moving On:

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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Alaska Air Group, there are three pertinent factors you should assess:

  1. Risks: Take risks, for example - Alaska Air Group has 1 warning sign we think you should be aware of.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ALK's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  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 NYSE every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.