- United States
Are Investors Undervaluing Ingersoll Rand Inc. (NYSE:IR) By 27%?
- The projected fair value for Ingersoll Rand is US$72.99 based on 2 Stage Free Cash Flow to Equity
- Ingersoll Rand's US$52.93 share price signals that it might be 27% undervalued
- Our fair value estimate is 13% lower than Ingersoll Rand's analyst price target of US$63.50
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Ingersoll Rand Inc. (NYSE:IR) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for Ingersoll Rand
Step By Step Through The Calculation
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||US$1.04b||US$1.17b||US$1.32b||US$1.52b||US$1.79b||US$1.99b||US$2.15b||US$2.28b||US$2.40b||US$2.49b|
|Growth Rate Estimate Source||Analyst x7||Analyst x7||Analyst x4||Analyst x2||Analyst x1||Est @ 10.67%||Est @ 8.09%||Est @ 6.28%||Est @ 5.02%||Est @ 4.13%|
|Present Value ($, Millions) Discounted @ 8.3%||US$957||US$995||US$1.0k||US$1.1k||US$1.2k||US$1.2k||US$1.2k||US$1.2k||US$1.2k||US$1.1k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$11b
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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 8.3%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$2.5b× (1 + 2.1%) ÷ (8.3%– 2.1%) = US$41b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$41b÷ ( 1 + 8.3%)10= US$18b
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$30b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$52.9, the company appears a touch undervalued at a 27% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
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 Ingersoll Rand 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 8.3%, which is based on a levered beta of 1.052. 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 Ingersoll Rand
- Earnings growth over the past year exceeded the industry.
- Debt is not viewed as a risk.
- Earnings growth over the past year is below its 5-year average.
- Dividend is low compared to the top 25% of dividend payers in the Machinery 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.
Although the valuation of a company is important, it 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. Why is the intrinsic value higher than the current share price? For Ingersoll Rand, we've put together three additional elements you should assess:
- Risks: To that end, you should be aware of the 1 warning sign we've spotted with Ingersoll Rand .
- Future Earnings: How does IR'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE 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 Ingersoll Rand 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.
Ingersoll Rand Inc. provides various mission-critical air, fluid, energy, specialty vehicle, and medical technologies in the United States, Europe, the Middle East, India, Africa, and the Asia Pacific.
Flawless balance sheet with acceptable track record.