Yahoo Finance Are Investors Undervaluing Charter Communications, Inc. (NASDAQ:CHTR) By 28%?
Key Insights
Charter Communications' estimated fair value is US$459 based on 2 Stage Free Cash Flow to Equity
Charter Communications' US$329 share price signals that it might be 28% undervalued
Analyst price target for CHTR is US$463 which is similar to our fair value estimate
In this article we are going to estimate the intrinsic value of Charter Communications, Inc. (NASDAQ:CHTR) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Check out our latest analysis for Charter Communications
The Model
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF ($, Millions) | US$4.42b | US$4.56b | US$4.62b | US$7.66b | US$8.06b | US$8.39b | US$8.67b | US$8.94b | US$9.18b | US$9.42b |
Growth Rate Estimate Source | Analyst x14 | Analyst x16 | Analyst x11 | Analyst x7 | Analyst x6 | Est @ 3.99% | Est @ 3.43% | Est @ 3.03% | Est @ 2.76% | Est @ 2.56% |
Present Value ($, Millions) Discounted @ 12% | US$4.0k | US$3.7k | US$3.3k | US$5.0k | US$4.7k | US$4.4k | US$4.0k | US$3.7k | US$3.4k | US$3.2k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$39b
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 (2.1%) 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 12%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$9.4b× (1 + 2.1%) ÷ (12%– 2.1%) = US$102b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$102b÷ ( 1 + 12%)10= US$34b
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$74b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$329, the company appears a touch undervalued at a 28% 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.
The 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 Charter Communications 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 12%, which is based on a levered beta of 1.582. 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 Charter Communications
Strength
No major strengths identified for CHTR.
Weakness
Earnings declined over the past year.
Interest payments on debt are not well covered.
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.
Annual earnings are forecast to grow slower than the American market.
Next Steps:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. Can we work out why the company is trading at a discount to intrinsic value? For Charter Communications, there are three important elements you should assess:
Risks: For example, we've discovered 1 warning sign for Charter Communications that you should be aware of before investing here.
Future Earnings: How does CHTR'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 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.
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.
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