The intrinsic value of Western Union Company (NYSE:WU) is potentially 92% higher than its stock price

How far is The Western Union Company (NYSE:WU) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model for this purpose. This may sound complicated, but it’s actually quite simple!

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.

Check out our latest analysis for Western Union

Is Western Union correctly valued?

We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:

Estimated free cash flow (FCF) over 10 years

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Leveraged FCF ($, millions)

$817.3 million

$944.3 million

$861.0 million

$744.0 million

$730.0 million

$725.3 million

$726.2 million

$731.0 million

$738.6 million

$748.2 million

Growth rate estimate Source

Analyst x4

Analyst x3

Analyst x2

Analyst x1

Analyst x1

Is @ -0.65%

Is at 0.12%

Is at 0.66%

Is at 1.04%

Is at 1.3%

Present value (millions of dollars) discounted at 7.0%

$764

$825

$703

$568

$521

$484

$453

$426

$403

$381

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $5.5 billion

The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 7.0%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = $748 million × (1 + 1.9%) ÷ (7.0%–1.9%) = $15 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= $15 billion ÷ (1 + 7.0%)ten= $7.7 billion

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $13 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $17.9, the company looks quite undervalued at a 48% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

dcf

The hypotheses

Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. You don’t have to agree with these entries, I recommend you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Western Union 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 takes debt into account. In this calculation, we used 7.0%, which is based on a leveraged beta of 1.191. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

While valuing a business is important, it ideally won’t be the only piece of analysis you look at for a business. DCF models are not the be-all and end-all of investment valuation. Instead, the best use of 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 pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. Why is intrinsic value higher than the current stock price? For Western Union, there are three relevant factors that you should examine in more detail:

  1. Risks: For example, we found 2 warning signs for Western Union (1 should not be ignored!) that you should consider before investing here.

  2. Management:Did insiders increase their shares to take advantage of market sentiment about WU’s future prospects? View our management and board analysis with insights into CEO compensation and governance factors.

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

PS. Simply Wall St updates its DCF calculation for every US stock daily, so if you want to find the intrinsic value of any other stock, do a search here.

Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.