Today we are going to review a valuation method used to estimate the attractiveness of Veritiv Corporation (NYSE: VRTV) as an investment opportunity by taking the company’s future cash flow forecast and by updating them to today’s value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something that interests you.
Check out our latest analysis for Veritiv
Is Veritiv correctly valued?
We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. To begin with, we need to get cash flow estimates for the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow down during this period. We do this to reflect that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :
10-year Free Cash Flow (FCF) estimate
|Leverage FCF ($, Millions)||US $ 140.3 million||$ 115.6 million||US $ 102.0 million||US $ 94.2 million||US $ 89.7 million||US $ 87.3 million||86.2 million USD||$ 85.9 million||US $ 86.2 million||US $ 86.9 million|
|Source of estimated growth rate||Is @ -26.04%||Is @ -17.63%||Is @ -11.75%||Is at -7.63%||Is @ -4.74%||East @ -2.72%||Is @ -1.31%||East @ -0.32%||East @ 0.37%||Is 0.86%|
|Present value ($, millions) discount at 10%||US $ 127||US $ 95.3||US $ 76.4||US $ 64.1||US $ 55.5||US $ 49.0||$ 43.9||$ 39.8||US $ 36.3||US $ 33.2|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 621 million
The second stage is also known as the terminal value, it is the cash flow of the business 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 used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 10%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US $ 87 million × (1 + 2.0%) ÷ (10% to 2.0%) = US $ 1.1 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 1.1 billion ÷ (1 + 10%)ten= US $ 418 million
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 1.0 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. From the current share price of US $ 61.4, the company appears to be roughly at fair value at a 7.4% discount from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
We emphasize that 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 results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Because we view Veritiv 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 takes into account debt. In this calculation, we used 10%, which is based on a leveraged beta of 1.717. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
While important, the DCF calculation ideally won’t be the only analysis you look at for a business. DCF models are not the alpha and omega of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. For Veritiv, we have put together three essential aspects to take into account:
- Risks: For example, we have identified 3 warning signs for Veritiv that you need to be aware of.
- Future benefits: How does VRTV’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might 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 Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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