FedEx Corporation (NYSE: FDX) Intrinsic Value Is Potentially 20% Less Than Its Stock Price

Does the FedEx Corporation (NYSE: FDX) stock price for May reflect what it is really worth? Today, we’re going to estimate the intrinsic value of the stock by taking the company’s expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it might seem quite complex.

Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. Anyone interested in learning a little more about intrinsic value should have a Simply Wall St analysis model.

Check out our latest analysis for FedEx

What is the estimated valuation?

We are going to use a two-step DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or the last published value. 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 during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.

Typically, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:

10-year free cash flow (FCF) estimate

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 25 billion USD

Now we need to calculate the terminal value, which takes into account all future cash flows after that 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 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 present value, using a cost of equity of 7.4%.

Terminal value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = $ 4.4 billion × (1 + 2.0%) ÷ (7.4% – 2.0%) = $ 82 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= 82 billion USD ÷ (1 + 7.4%)^ten= 40 billion USD

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is US $ 65 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of US $ 309, the company appears to be slightly overvalued at the time of writing. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.

Important assumptions

We draw your attention to the fact that the most important data for a discounted cash flow is the discount rate and of course the actual cash flow. 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 complete picture of a company’s potential performance. Since we view FedEx 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 7.4%, which is based on a leveraged beta of 1.151. 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 of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

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 business. DCF models are not the alpha and omega of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. 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. Why is intrinsic value lower than the current share price? For FedEx, there are three essentials you should consider:

1. Risks: Every company has them, and we have spotted 2 warning signs for FedEx you should know.
2. Future income: How does FDX’s growth rate compare to its peers and to the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high quality inventory 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 any stock, and does not take into account your goals or your financial situation. We aim 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 information. Simply Wall St has no position in the mentioned stocks.
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