Negative Equity Value/Share Price in DCF?

Hi all, I need some help regarding a DCF I made. For some context, the company is an industrial company with very high NWC that significantly reduces FCF. It also has an average 6% operating margin for the past few years. The combination of a low ebit, high increasing NWC, and high debt make it so the EV that my DCF spits out is significantly below the company’s market equity value. In addition, when going from EV to equity value, the small cash and very large debt turns the equity value in my DCF negative, resulting in negative price per share. Any suggestions on if this is normal or any mistakes I might have made? Thank you for the help!

 

You made a very good point. That led me to figuring out what the average 5 year historical NWC growth was and I found that it’s grown at 16% on average. For the sake of not coming up with a negative share price I decided to reduce that growth to 5% in future projections for FCF that feeds into my DCF. Any other suggestions? I also reduced net PPE/capex growth to 3%. Both changes helped but share price is still 12% of market price

 
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Few things to note.

  • How are you projecting the CapEx? Are you doing it as a % of revenue? If so, look at the historicals to see what the composition of the CapEx has been, if accessible, because it would be critical to distinguish between maintenance CapEx and growth CapEx, maybe you can tune down the growth but keep the maintenance fixed, rather than just lumping them together (which could be reflecting inaccurately in the model)
  • Segmentate the revenues by business lines or by unit economics or something else; are you doing a catch-all singular revenue % growth number? This is usually where the issue is since everything is tied to revenue growth (literally everything) so just throwing 5% overall isn't accurate enough
  • Lower your WACC by using a more accommodating target capital structure, sure maybe debt is the majority of the cap structure right now but maybe you can incorporate for deleveraging in your projections and justify a more friendly capital structure (60/40 rather than 40/60 equity to debt split, for instance).

Happy to expand if you provide more context

 

Second this. Would also take a look at how you’re projecting NWC since a standalone growth rate on NWC doesn’t really make sense. Maybe try breaking out NWC line by line or see if you can project it on a working capital turnover rate.

Also, based on what you’ve mentioned about slim margins and capital intensity, it would make some sense that you are seeing a negative or low value depending on how high your wacc is. Any info on the company you’re analyzing?

 
  • look at the NWC or its components vs sales & costs. Not in isolation. Nwc is a cash conversion point: you may build WC in growth phase, but then normalize in steady state
  • make sure your dcf goes to steady state
  • do a check against ROIC or ROCE to see if your model makes sense since it’s capital intensive. You should get to a point where ROIC is in line or superior to hour WACC. If not, then wouldn’t do these investments in capex and WC!
 

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