Key Insights

Using the 2 Stage Free Cash Flow to Equity, Westinghouse Air Brake Technologies fair value estimate is US$247 Current share price of US$190 suggests Westinghouse Air Brake Technologies is potentially 23% undervalued Analyst price target for WAB is US$210 which is 15% below our fair value estimate

How far off is Westinghouse Air Brake Technologies Corporation (NYSE:WAB) 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. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF ($, Millions)  US$1.38b US$1.66b US$1.88b US$2.03b US$2.16b US$2.27b US$2.37b US$2.47b US$2.56b US$2.64b Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x2 Est @ 7.92% Est @ 6.37% Est @ 5.28% Est @ 4.52% Est @ 3.99% Est @ 3.62% Est @ 3.36% Present Value ($, Millions) Discounted @ 7.5%  US$1.3k US$1.4k US$1.5k US$1.5k US$1.5k US$1.5k US$1.4k US$1.4k US$1.3k US$1.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$14b

Story Continues

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.8%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.5%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$2.6b× (1 + 2.8%) ÷ (7.5%– 2.8%) = US$58b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$58b÷ ( 1 + 7.5%)10= US$28b

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$42b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$190, the company appears a touch undervalued at a 23% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.NYSE:WAB Discounted Cash Flow May 8th 2025

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 Westinghouse Air Brake Technologies 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 7.5%, which is based on a levered beta of 1.089. 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.

Check out our latest analysis for Westinghouse Air Brake Technologies

SWOT Analysis for Westinghouse Air Brake Technologies

Strength

Earnings growth over the past year exceeded the industry.

Debt is not viewed as a risk.

Weakness

Earnings growth over the past year is below its 5-year average.

Dividend is low compared to the top 25% of dividend payers in the Machinery market.

Opportunity

Annual earnings are forecast to grow for the next 3 years.

Trading below our estimate of fair value by more than 20%.

Threat

Annual earnings are 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. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price sitting below the intrinsic value? For Westinghouse Air Brake Technologies, there are three important factors you should further research:

Risks: To that end, you should be aware of the  1 warning sign  we've spotted with Westinghouse Air Brake Technologies . Future Earnings: How does WAB'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. 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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