Does the March share price for Vulcan Materials (NYSE:VMC) reflect its intrinsic value? I am going to calculate it now using a method called discounted cash flow or DCF. A discounted cash flow (DCF) analysis represents the net present value (NPV) of projected cash flows to a stock. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model.
If you are reading this and its not March 2017 then I highly recommend you check out the latest calculation for Vulcan Materials by following the link below. View our latest analysis for Vulcan Materials
I use what is known as a 2-stage model, which simply means we have two different periods where we need to estimate cash flows. To start off with we need to estimate the next 5 years of cash flows, where possible I use analysts estimates but when these aren’t available I have extrapolated the previous Free Cash Flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past 5 years, but capped to a reasonable level. The sum of these cash flows is then discounted to today’s value.
Step by step through the calculation
Note the numbers here are in millions apart from the per share values.
5-year cash flow forecast
2017 | 2018 | 2019 | 2020 | 2021 | |
Levered FCF (USD, Millions) | $525.80 | $672.60 | $734.37 | $801.80 | $875.43 |
Source | Analyst x2 | Analyst x2 | Extrapolated @ (9.18%) | Extrapolated @ (9.18%) | Extrapolated @ (9.18%) |
Present Value Discounted @ 8.49% | $484.64 | $571.41 | $575.04 | $578.69 | $582.36 |
Present value of next 5 years cash flows: $2,792
After calculating the present value of cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the 1st stage. The Perpetuity Method (Gordon Formula) is used to calculate Terminal Value at an annual growth rate equal to the 10 year government bond rate of (2.5%).
Terminal Value
Terminal Value = FCF_{2021} × (1 + g) ÷ (Discount Rate – g)
Terminal Value = $875 × (1 + 2.5%) ÷ (8.5% – 2.5%)
Terminal value based on the Perpetuity Method where growth (g) = 2.5%: $14,891
Present value of terminal value: $9,906
The total value or equity value is then the sum of of the present value of the cash flows.
Equity Value
Equity Value (Total value) = Present value of next 5 years cash flows + terminal value = $2,792 + $9,906 = $12,698
In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number.
Value = Total value / Shares Outstanding ($12,698.32 / 132.36)
Value per share: $95.94
Now when we compare the intrinsic value of 95.94 to the current share price of $121.32 we find Vulcan Materials (NYSE:VMC) is slightly overvalued at the time of writing.
Important assumptions
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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Vulcan Materials as potential investors the Cost of Equity is used as the discount rate, not the Cost of Capital (or Weighed Average Cost of Capital/ WACC) which accounts for debt.
In this calculation I’ve used 8.5% and this is based on a Levered Beta of 0.8. I’m not going to go into how I calculate the Levered Beta in detail, I used the ‘Bottom up Beta’ method based on the comparable businesses, I also impose a limit between 0.8 and 2 which is a reasonable range for a stable business. Google this if you want to learn more.
Conclusion
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. Is Vulcan Materials in a healthy financial condition? What is the reason for the share price to differ from the intrinsic value? See our latest FREE analysis to find out!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the NYSE every 6 hours. If you want to find the calculation for another other stock just search here.