Are Investors Undervaluing Systemax Inc. (NYSE:SYX) By 48%?

Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of Systemax Inc. (NYSE:SYX) as an investment opportunity by taking the expected future cash flows and discounting them to their present 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Systemax

The calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
Levered FCF ($, Millions) US$33.9m US$50.2m US$63.0m US$74.8m US$85.0m US$93.7m US$101.1m US$107.3m US$112.7m US$117.3m
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ 25.66% Est @ 18.63% Est @ 13.71% Est @ 10.26% Est @ 7.85% Est @ 6.16% Est @ 4.98% Est @ 4.15%
Present Value ($, Millions) Discounted @ 8.0% US$31.4 US$43.0 US$50.0 US$55.0 US$57.9 US$59.1 US$59.0 US$58.0 US$56.4 US$54.4

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$524m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 2.2%. We discount the terminal cash flows to today’s value at a cost of equity of 8.0%.

Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = US$117m× (1 + 2.2%) ÷ 8.0%– 2.2%) = US$2.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.1b÷ ( 1 + 8.0%)10= US$963m

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$1.5b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$20.6, the company appears quite good value at a 48% 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.

NYSE:SYX Intrinsic value June 2nd 2020
NYSE:SYX Intrinsic value June 2nd 2020

The assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Systemax 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 8.0%, which is based on a levered beta of 0.961. 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.

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 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 Systemax, We’ve put together three essential aspects you should further examine:

  1. Risks: We feel that you should assess the 2 warning signs for Systemax we’ve flagged before making an investment in the company.
  2. Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for SYX’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks 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.