Does the June share price for TechnipFMC plc (NYSE:FTI) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. I will use the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.
Step by step through the calculation
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 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) forecast
|Levered FCF ($, Millions)||US$193.9m||US$306.6m||US$371.5m||US$552.0m||US$827.0m||US$1.03b||US$1.21b||US$1.37b||US$1.50b||US$1.62b|
|Growth Rate Estimate Source||Analyst x15||Analyst x15||Analyst x6||Analyst x3||Analyst x2||Est @ 24.37%||Est @ 17.73%||Est @ 13.08%||Est @ 9.82%||Est @ 7.54%|
|Present Value ($, Millions) Discounted @ 16%||US$167||US$228||US$238||US$304||US$393||US$421||US$427||US$416||US$394||US$365|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.4b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 10-year government bond rate (2.2%) 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 16%.
Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = US$1.6b× (1 + 2.2%) ÷ 16%– 2.2%) = US$12b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$12b÷ ( 1 + 16%)10= US$2.7b
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$6.0b. 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$8.1, the company appears quite undervalued at a 40% 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 TechnipFMC 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 16%, which is based on a levered beta of 2.000. 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.
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 to differ from the intrinsic value? For TechnipFMC, We've put together three fundamental aspects you should look at:
- Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with TechnipFMC , and understanding these should be part of your investment process.
- Future Earnings: How does FTI'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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.