Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of Flowers Foods, Inc. (NYSE:FLO) as an investment opportunity by taking the expected future cash flows and discounting them to today’s value. Our analysis will employ 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 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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out the: opportunities and risks within the US Food industry.
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 begin with, we have to get estimates of 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 down 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.
10-year free cash flow (FCF) estimate
|Leveraged FCF ($, Millions)||US$282.3m||US$337.0m||US$377.3m||US$411.0m||US$439.3m||US$463.0m||US$483.2m||US$500.9m||US$516.7m||US$531.1m|
|Growth Rate Estimate Source:||Analyst x2:||Analyst x1:||Est @ 11.95%||Est @ 8.96%||Est @ 6.86%||Est @ 5.4%||Est @ 4.37%||Est @ 3.65%||Est @ 3.15%||Est @ 2.8%|
|Present Value ($, Millions) Discounted @ 6.1%||US$266||US$299||US$316||US$325||US$327||US$325||US$320||US$312||US$304||US$294|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.1b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.0%. We discount the terminal cash flows to today’s value at a cost of equity of 6.1%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$531m × (1 + 2.0%) ÷ (6.1% – 2.0%) = US$13b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10:00= US$13b÷ ( 1 + 6.1%)10:00= US$7.3b
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$10b. 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$29.6, the company appears quite good value at a 40% discount to where the stock price currently trades. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you do not agree with these results, 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 Flowers Foods 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 6.1%, 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 Flowers Foods
- Debt is well covered by earnings and cashflows.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Food market.
- Annual earnings are forecast to grow for the next 3 years.
- Trading below our estimate of fair value by more than 20%.
- Dividends are not covered by cash flow.
- Annual earnings are forecast to grow slower than the American market.
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. Can we work out why the company is trading at a discount to intrinsic value? For Flowers Foods, we’ve compiled three important factors you should consider.
- Risks:: To that end, you should be aware of the 2 warning signs: we’ve spotted with Flowers Foods.
- Future Earnings:: How does FLO’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!
P.S. 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.
Valuation is complex, but we’re helping to make it simple.
Find out whether Flowers Foods is potentially over or undervalued by checking out our comprehensive analysis, which includes: fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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 into account 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.