Are Investors Undervaluing UFP Industries, Inc. (NASDAQ:UFPI) By 42%?

September 29, 2022
  •  Updated
October 11, 2022
NasdaqGS:UFPI
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Does the September share price for UFP Industries, Inc. (NASDAQ:UFPI) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

Check out our latest analysis for UFP Industries

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. To start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$495.4m US$446.3m US$418.0m US$401.9m US$393.3m US$389.8m US$389.6m US$391.7m US$395.5m US$400.5m
Growth Rate Estimate Source Analyst x3 Est @ -9.9% Est @ -6.35% Est @ -3.86% Est @ -2.12% Est @ -0.9% Est @ -0.05% Est @ 0.55% Est @ 0.96% Est @ 1.26%
Present Value ($, Millions) Discounted @ 6.6% US$465 US$393 US$345 US$311 US$286 US$266 US$249 US$235 US$223 US$212

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.0b

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 5-year average of the 10-year government bond yield of 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 6.6%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$400m× (1 + 1.9%) ÷ (6.6%– 1.9%) = US$8.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$8.8b÷ ( 1 + 6.6%)10= US$4.7b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$7.6b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$72.3, the company appears quite undervalued at a 42% 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.

dcf
NasdaqGS:UFPI Discounted Cash Flow September 29th 2022

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 UFP 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 6.6%, which is based on a levered beta of 1.093. 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.

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For UFP Industries, we've put together three essential elements you should assess:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with UFP Industries (at least 1 which shouldn't be ignored) , and understanding these should be part of your investment process.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for UFPI'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 NASDAQGS every day. If you want to find the calculation for other stocks just search here.

Valuation is complex, but we're helping make it simple.

Find out whether UFP 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.

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