Using the 2 Stage Free Cash Flow to Equity, FirstEnergy fair value estimate is US$66.26
FirstEnergy's US$38.92 share price signals that it might be 41% undervalued
The US$41.80 analyst price target for FE is 37% less than our estimate of fair value
Does the July share price for FirstEnergy Corp. (NYSE:FE) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Is FirstEnergy Fairly Valued?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF ($, Millions)
US$947.0m
US$1.13b
US$1.26b
US$1.37b
US$1.47b
US$1.55b
US$1.62b
US$1.68b
US$1.74b
US$1.80b
Growth Rate Estimate Source
Analyst x1
Analyst x1
Est @ 11.79%
Est @ 8.96%
Est @ 6.99%
Est @ 5.61%
Est @ 4.64%
Est @ 3.96%
Est @ 3.49%
Est @ 3.15%
Present Value ($, Millions) Discounted @ 6.1%
US$893
US$1.0k
US$1.1k
US$1.1k
US$1.1k
US$1.1k
US$1.1k
US$1.1k
US$1.0k
US$998
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$10b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.1%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$50b÷ ( 1 + 6.1%)10= US$28b
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$38b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$38.9, the company appears quite undervalued at a 41% discount to where the stock price trades currently. 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.
NYSE:FE Discounted Cash Flow July 11th 2024
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 FirstEnergy 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 6.1%, which is based on a levered beta of 0.800. 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 FirstEnergy
Strength
Earnings growth over the past year exceeded the industry.
Dividend is low compared to the top 25% of dividend payers in the Electric Utilities market.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Good value based on P/E ratio and estimated fair value.
Threat
Debt is not well covered by operating cash flow.
Paying a dividend but company has no free cash flows.
Annual earnings are forecast to grow slower than the American market.
Is FE well equipped to handle threats?
Next Steps:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. 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 higher than the current share price? For FirstEnergy, there are three pertinent items you should further examine:
Risks: As an example, we've found 2 warning signs for FirstEnergy (1 makes us a bit uncomfortable!) that you need to consider before investing here.
Future Earnings: How does FE'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.
Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
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オーストラリアでは、moomooの投資商品及びサービスはMoomoo Securities Australia Limitedによって提供され、オーストラリア証券投資委員会(ASIC)の管理を受けております(AFSL No. 224663)。「金融サービスガイド」、「利用規約」、「プライバシーポリシー」などの詳細は、Moomoo Securities Australia Limitedのウェブサイトhttps://www.moomoo.com/auでご確認いただけます。