How far off is Zebra Technologies (NASDAQ:ZBRA) to its intrinsic value? I am going to take a look now by estimating the Future Cash Flows and discounting them to their present value. Discounted Cash Flow or DCF is a direct valuation technique that values a company by projecting its future cash flows and then discounting them to todays money. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
If you are reading this and its not April 2017 then I highly recommend you check out the latest calculation for Zebra Technologies by following the link below. View our latest analysis for Zebra Technologies
We are going to use a two stage model that takes into account two stages of growth. The first stage may have a high growth rate and the second stage is usually assumed to have a stable growth rate. To start off with we need to predict 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.
Detailed calculation
Please note that the numbers here are in millions apart from the per share values.
5-year cash flow estimate
2017 | 2018 | 2019 | 2020 | 2021 | |
Levered FCF (USD, Millions) | $319.02 | $405.26 | $478.20 | $559.50 | $649.01 |
Source | Analyst x4 | Analyst x4 | Extrapolated @ (18%, capped from 48.98%) | Extrapolated @ (17%, capped from 48.98%) | Extrapolated @ (16%, capped from 48.98%) |
Present Value Discounted @ 10.87% | $287.75 | $329.69 | $350.90 | $370.31 | $387.45 |
Present value of next 5 years cash flows: $1,726
The 2nd stage is also known as Terminal Value, this is the cash flows to the business after the 1st stage. For a number of reasons a very conservative rate is used that cannot exceed that of the GDP. In this case I have used the 10 year government bond rate (2.5%). In the same way as with the 5 year ‘growth’ period we discount this to today’s value.
Terminal Value
Terminal Value = FCF_{2021} × (1 + g) ÷ (Discount Rate – g)
Terminal Value = $649 × (1 + 2.5%) ÷ (10.9% – 2.5%)
Terminal value based on the Perpetuity Method where growth (g) = 2.5%: $7,919
Present value of terminal value: $4,727
So the total value is the sum of the next 5 years cash flows and the terminal value discounted to today, this is known as the Equity Value.
Equity Value
Equity Value (Total value) = Present value of next 5 years cash flows + terminal value = $1,726 + $4,727 = $6,453
The last step is to then 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) then we use the equivalent number.
Value = Total value / Shares Outstanding ($6,453.34 / 52.49)
Value per share: $122.94
Finally if we compare the intrinsic value of 122.94 to the current share price of $90.82 we see Zebra Technologies (NasdaqGS:ZBRA) is a touch undervalued at a 26% discount to what it is available for right now.
The 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 Zebra Technologies 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 10.9% and this is based on a Levered Beta of 1.115. 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.
Final Words
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. Is Zebra Technologies 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. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.