In This Article:
Key Insights
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Avista's estimated fair value is US$43.25 based on Dividend Discount Model
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Current share price of US$36.19 suggests Avista is potentially trading close to its fair value
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Analyst price target for AVA is US$40.25 which is 6.9% below our fair value estimate
In this article we are going to estimate the intrinsic value of Avista Corporation (NYSE:AVA) by taking the expected future cash flows and discounting them to today's value. This will be done using 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
View our latest analysis for Avista
The Calculation
We have to calculate the value of Avista slightly differently to other stocks because it is a integrated 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. The 'Gordon Growth Model' is used, which simply assumes that dividend payments will continue to increase at a sustainable growth rate forever. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.6%. We then discount this figure to today's value at a cost of equity of 5.9%. Relative to the current share price of US$36.2, the company appears about fair value at a 16% 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.
Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)
= US$2.0 / (5.9% – 2.6%)
= US$43.2
The Assumptions
We would point out that 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 Avista 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 5.9%, 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.