Today we will run through one way of estimating the intrinsic value of Modine Manufacturing Company (NYSE:MOD) 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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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We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF ($, Millions) | US$136.9m | US$203.5m | US$249.2m | US$283.6m | US$313.5m | US$339.1m | US$361.3m | US$380.9m | US$398.4m | US$414.6m |
Growth Rate Estimate Source | Analyst x4 | Analyst x4 | Analyst x3 | Est @ 13.83% | Est @ 10.51% | Est @ 8.18% | Est @ 6.55% | Est @ 5.41% | Est @ 4.61% | Est @ 4.05% |
Present Value ($, Millions) Discounted @ 7.2% | US$128 | US$177 | US$202 | US$214 | US$221 | US$223 | US$221 | US$218 | US$212 | US$206 |
("Est" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = US$2.0b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$415m× (1 + 2.8%) ÷ (7.2%– 2.8%) = US$9.5b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$9.5b÷ ( 1 + 7.2%)10= US$4.7b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$6.7b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$79.3, the company appears quite good value at a 38% 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.
Now 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 Modine Manufacturing 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 7.2%, which is based on a levered beta of 1.039. 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 Modine Manufacturing
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. Why is the intrinsic value higher than the current share price? For Modine Manufacturing, we've compiled three additional elements you should further examine:
PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.
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