- United States
- /
- Electrical
- /
- NYSE:AYI
Acuity Brands, Inc.'s (NYSE:AYI) Intrinsic Value Is Potentially 36% Above Its Share Price
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Acuity Brands fair value estimate is US$242
- Acuity Brands is estimated to be 27% undervalued based on current share price of US$177
- Our fair value estimate is 28% higher than Acuity Brands' analyst price target of US$189
Today we will run through one way of estimating the intrinsic value of Acuity Brands, Inc. (NYSE:AYI) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
See our latest analysis for Acuity Brands
Is Acuity Brands Fairly Valued?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$446.5m | US$452.1m | US$458.8m | US$466.6m | US$475.3m | US$484.7m | US$494.6m | US$504.9m | US$515.7m | US$526.8m |
Growth Rate Estimate Source | Analyst x5 | Analyst x3 | Est @ 1.48% | Est @ 1.70% | Est @ 1.86% | Est @ 1.97% | Est @ 2.04% | Est @ 2.10% | Est @ 2.13% | Est @ 2.16% |
Present Value ($, Millions) Discounted @ 8.1% | US$413 | US$387 | US$363 | US$342 | US$322 | US$304 | US$287 | US$271 | US$256 | US$242 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.2b
The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.2%) 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 8.1%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$527m× (1 + 2.2%) ÷ (8.1%– 2.2%) = US$9.2b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$9.2b÷ ( 1 + 8.1%)10= US$4.2b
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$7.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$177, the company appears a touch undervalued at a 27% 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 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. 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 Acuity Brands 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 8.1%, which is based on a levered beta of 1.173. 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 Acuity Brands
- Debt is not viewed as a risk.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Electrical market.
- Annual earnings are forecast to grow for the next 3 years.
- Trading below our estimate of fair value by more than 20%.
- Annual earnings are forecast to grow slower than the American market.
Next Steps:
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Acuity Brands, we've put together three fundamental items you should further research:
- Financial Health: Does AYI have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does AYI'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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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 NYSE:AYI
Acuity Brands
Provides lighting, lighting controls, building management system, location-aware applications in the United States and internationally.
Solid track record with excellent balance sheet.