How far off is IDACORP, Inc. (NYSE:IDA) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it’s not too difficult to follow, as you’ll see from our example!
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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Is IDACORP Fairly Valued?
We have to calculate the value of IDACORP slightly differently to other stocks because it is a electric utilities company. Instead of using free cash flows, which are hard to estimate and often not reported by analysts in this industry, dividends per share (DPS) payments are used. This often underestimates the value of a stock, but it can still be good as a comparison to competitors. We use the Gordon Growth Model, which assumes dividend will grow into perpetuity at a rate that can be sustained. For a number of reasons a very conservative growth rate is used that cannot exceed that of a company’s Gross Domestic Product (GDP). In this case we used the 5-year average of the 10-year government bond yield (3.3%). The expected dividend per share is then discounted to today’s value at a cost of equity of 7.0%. Relative to the current share price of US$128, the company appears slightly overvalued at the time of writing. 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.
Value Per Share = Expected Dividend Per Share / (Discount Rate – Perpetual Growth Rate)
= US$3.8 / (7.0% – 3.3%)
= US$103
Important Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 IDACORP 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 7.0%, 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 IDACORP
Strength
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Earnings growth over the past year exceeded the industry.
Weakness
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Interest payments on debt are not well covered.
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Dividend is low compared to the top 25% of dividend payers in the Electric Utilities market.
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Expensive based on P/E ratio and estimated fair value.
Opportunity
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Annual earnings are forecast to grow for the next 3 years.
Threat
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Debt is not well covered by operating cash flow.
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Paying a dividend but company has no free cash flows.
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Annual earnings are forecast to grow slower than the American market.
Looking Ahead:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price exceeding the intrinsic value? For IDACORP, there are three important factors you should further research:
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Risks: As an example, we’ve found 2 warning signs for IDACORP (1 is a bit unpleasant!) that you need to consider before investing here.
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Future Earnings: How does IDA’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.
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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!