Stock Analysis
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Kadant fair value estimate is US$294
- Kadant's US$349 share price indicates it is trading at similar levels as its fair value estimate
- Analyst price target for KAI is US$342, which is 16% above our fair value estimate
Today we will run through one way of estimating the intrinsic value of Kadant Inc. (NYSE:KAI) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Kadant
What's The Estimated Valuation?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF ($, Millions) | US$142.2m | US$147.7m | US$153.0m | US$158.0m | US$162.8m | US$167.6m | US$172.3m | US$177.1m | US$182.0m | US$186.9m |
Growth Rate Estimate Source | Analyst x1 | Est @ 3.93% | Est @ 3.54% | Est @ 3.26% | Est @ 3.07% | Est @ 2.93% | Est @ 2.84% | Est @ 2.77% | Est @ 2.73% | Est @ 2.70% |
Present Value ($, Millions) Discounted @ 6.9% | US$133 | US$129 | US$125 | US$121 | US$117 | US$112 | US$108 | US$104 | US$99.9 | US$95.9 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.1b
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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 6.9%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$187m× (1 + 2.6%) ÷ (6.9%– 2.6%) = US$4.5b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.5b÷ ( 1 + 6.9%)10= US$2.3b
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$3.5b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$349, the company appears around fair value at the time of writing. 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.
Important Assumptions
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 Kadant 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 6.9%, which is based on a levered beta of 1.037. 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 Kadant
- Debt is not viewed as a risk.
- Earnings growth over the past year underperformed the Machinery industry.
- Dividend is low compared to the top 25% of dividend payers in the Machinery market.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow for the next 3 years.
- Annual earnings are forecast to grow slower than the American market.
Looking Ahead:
Although the valuation of a company is important, it 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Kadant, we've put together three relevant items you should look at:
- Risks: For instance, we've identified 1 warning sign for Kadant that you should be aware of.
- Future Earnings: How does KAI'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. 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 here to simplify it.
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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.
About NYSE:KAI
Kadant
Supplies technologies and engineered systems worldwide.