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- LSE:JMAT
Johnson Matthey Plc (LON:JMAT) Shares Could Be 49% Below Their Intrinsic Value Estimate
Key Insights
- Johnson Matthey's estimated fair value is UK£32.57 based on 2 Stage Free Cash Flow to Equity
- Current share price of UK£16.61 suggests Johnson Matthey is potentially 49% undervalued
- Analyst price target for JMAT is UK£21.00 which is 36% below our fair value estimate
Today we will run through one way of estimating the intrinsic value of Johnson Matthey Plc (LON:JMAT) by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for Johnson Matthey
The Calculation
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (£, Millions) | UK£269.4m | UK£177.0m | UK£189.6m | UK£303.0m | UK£403.5m | UK£478.8m | UK£543.1m | UK£596.1m | UK£639.1m | UK£673.8m |
Growth Rate Estimate Source | Analyst x5 | Analyst x3 | Analyst x4 | Analyst x2 | Analyst x2 | Est @ 18.65% | Est @ 13.43% | Est @ 9.77% | Est @ 7.21% | Est @ 5.42% |
Present Value (£, Millions) Discounted @ 9.7% | UK£246 | UK£147 | UK£144 | UK£210 | UK£254 | UK£275 | UK£285 | UK£285 | UK£279 | UK£268 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£2.4b
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. 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 have used the 5-year average of the 10-year government bond yield (1.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 9.7%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£674m× (1 + 1.2%) ÷ (9.7%– 1.2%) = UK£8.1b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£8.1b÷ ( 1 + 9.7%)10= UK£3.2b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£5.6b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£16.6, the company appears quite good value at a 49% 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.
The Assumptions
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 Johnson Matthey 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 9.7%, which is based on a levered beta of 1.208. 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 Johnson Matthey
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings.
- Dividend is low compared to the top 25% of dividend payers in the Chemicals market.
- Annual earnings are forecast to grow faster than the British market.
- Good value based on P/E ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Paying a dividend but company has no free cash flows.
- Annual revenue is expected to decline over the next 3 years.
Next Steps:
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Why is the intrinsic value higher than the current share price? For Johnson Matthey, we've put together three further aspects you should explore:
- Risks: Take risks, for example - Johnson Matthey has 1 warning sign we think you should be aware of.
- Future Earnings: How does JMAT'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the LSE every day. If you want to find the calculation for other stocks just search here.
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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About LSE:JMAT
Johnson Matthey
Engages in the clean air, catalyst and hydrogen technology, and platinum group metals (PGM) service businesses in the United Kingdom, Germany, rest of Europe, the United States, rest of North America, China, rest of Asia, and internationally.
Very undervalued with solid track record.