Is There An Opportunity With Custom Truck One Source, Inc.'s (NYSE:CTOS) 36% Undervaluation?

Custom Truck One Source Inc -1.57%

Custom Truck One Source Inc

CTOS

5.65

-1.57%

Key Insights

  • The projected fair value for Custom Truck One Source is US$9.62 based on 2 Stage Free Cash Flow to Equity
  • Custom Truck One Source is estimated to be 36% undervalued based on current share price of US$6.18
  • Our fair value estimate is 6.9% higher than Custom Truck One Source's analyst price target of US$9.00

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Custom Truck One Source, Inc. (NYSE:CTOS) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

See our latest analysis for Custom Truck One Source

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 begin with, we have to get estimates of 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$202.9m US$209.0m US$214.3m US$219.6m US$224.9m US$230.1m US$235.4m US$240.8m US$246.2m US$251.7m
Growth Rate Estimate Source Analyst x2 Analyst x1 Est @ 2.56% Est @ 2.46% Est @ 2.39% Est @ 2.34% Est @ 2.30% Est @ 2.28% Est @ 2.26% Est @ 2.25%
Present Value ($, Millions) Discounted @ 11% US$183 US$170 US$157 US$144 US$133 US$123 US$113 US$104 US$96.0 US$88.4

("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. 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$252m× (1 + 2.2%) ÷ (11%– 2.2%) = US$2.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.9b÷ ( 1 + 11%)10= US$1.0b

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$2.3b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$6.2, the company appears quite undervalued at a 36% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
NYSE:CTOS Discounted Cash Flow December 30th 2023

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Custom Truck One Source 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 11%, which is based on a levered beta of 1.763. 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 Custom Truck One Source

Strength
  • Earnings growth over the past year exceeded the industry.
Weakness
  • Interest payments on debt are not well covered.
Opportunity
  • Annual earnings are forecast to grow faster than the American market.
  • Good value based on P/E ratio and estimated fair value.
  • Significant insider buying over the past 3 months.
Threat
  • Debt is not well covered by operating cash flow.
  • Annual revenue is forecast to grow slower than the American market.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Custom Truck One Source, we've compiled three further items you should look at:

  1. Risks: To that end, you should learn about the 2 warning signs we've spotted with Custom Truck One Source (including 1 which makes us a bit uncomfortable) .
  2. Future Earnings: How does CTOS'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. 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.

Every question you ask will be answered
Scan the QR code to contact us
whatsapp
Also you can contact us via