- United States
Is There An Opportunity With AZZ Inc.'s (NYSE:AZZ) 47% Undervaluation?
- AZZ's estimated fair value is US$73.12 based on 2 Stage Free Cash Flow to Equity
- Current share price of US$38.65 suggests AZZ is potentially 47% undervalued
- Our fair value estimate is 29% lower than AZZ's analyst price target of US$52.00
Does the March share price for AZZ Inc. (NYSE:AZZ) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for AZZ
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
|Levered FCF ($, Millions)||US$82.9m||US$124.5m||US$153.7m||US$175.5m||US$194.0m||US$209.5m||US$222.5m||US$233.6m||US$243.2m||US$251.7m|
|Growth Rate Estimate Source||Analyst x2||Analyst x2||Analyst x2||Est @ 14.17%||Est @ 10.54%||Est @ 8.00%||Est @ 6.22%||Est @ 4.97%||Est @ 4.10%||Est @ 3.49%|
|Present Value ($, Millions) Discounted @ 12%||US$74.1||US$99.3||US$110||US$112||US$110||US$107||US$101||US$94.8||US$88.1||US$81.5|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$977m
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 (2.1%) 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 12%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$252m× (1 + 2.1%) ÷ (12%– 2.1%) = US$2.6b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.6b÷ ( 1 + 12%)10= US$843m
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$1.8b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$38.7, the company appears quite good value at a 47% 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 AZZ 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 12%, which is based on a levered beta of 1.661. 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 AZZ
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings.
- Dividends are covered by earnings and cash flows.
- Dividend is low compared to the top 25% of dividend payers in the Building market.
- Annual earnings are forecast to grow faster than the American market.
- Good value based on P/E ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Annual revenue is forecast to grow slower than the American market.
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. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For AZZ, we've compiled three essential aspects you should further research:
- Risks: You should be aware of the 1 warning sign for AZZ we've uncovered before considering an investment in the company.
- Future Earnings: How does AZZ'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.
Valuation is complex, but we're helping make it simple.
Find out whether AZZ 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.
AZZ Inc. offers galvanizing and metal coating solutions, welding solutions, specialty electrical equipment, and engineered services to the power generation, transmission, distribution, refining, and industrial markets in the United States and internationally.
Undervalued established dividend payer.