- James Hardie Industries' estimated fair value is AU$59.82 based on 2 Stage Free Cash Flow to Equity
- Current share price of AU$41.53 suggests James Hardie Industries is potentially 31% undervalued
- Analyst price target for JHX is US$49.94 which is 17% below our fair value estimate
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of James Hardie Industries plc (ASX:JHX) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Is James Hardie Industries Fairly Valued?
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||US$224.9m||US$424.1m||US$415.9m||US$544.3m||US$787.0m||US$915.3m||US$1.03b||US$1.12b||US$1.19b||US$1.26b|
|Growth Rate Estimate Source||Analyst x5||Analyst x4||Analyst x4||Analyst x2||Analyst x2||Est @ 16.30%||Est @ 12.01%||Est @ 9.01%||Est @ 6.91%||Est @ 5.44%|
|Present Value ($, Millions) Discounted @ 7.4%||US$209||US$368||US$336||US$410||US$552||US$598||US$624||US$633||US$631||US$619|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$5.0b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$1.3b× (1 + 2.0%) ÷ (7.4%– 2.0%) = US$24b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$24b÷ ( 1 + 7.4%)10= US$12b
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$17b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$41.5, the company appears quite good value at a 31% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. 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 James Hardie Industries 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 7.4%, which is based on a levered beta of 0.905. 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.
SWOT Analysis for James Hardie Industries
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings and cashflows.
- Earnings growth over the past year is below its 5-year average.
- Annual earnings are forecast to grow faster than the Australian market.
- Trading below our estimate of fair value by more than 20%.
- Revenue is forecast to grow slower than 20% per year.
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 sitting below the intrinsic value? For James Hardie Industries, we've compiled three pertinent factors you should assess:
- Risks: For example, we've discovered 1 warning sign for James Hardie Industries that you should be aware of before investing here.
- Future Earnings: How does JHX's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- 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. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock just search here.
Valuation is complex, but we're helping make it simple.
Find out whether James Hardie Industries is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
James Hardie Industries
James Hardie Industries plc manufactures and sells fiber cement, fiber gypsum, and cement bonded building products for interior and exterior building construction applications primarily in the United States, Australia, Europe, New Zealand, and the Philippines.
Reasonable growth potential with adequate balance sheet.