# Calculating The Fair Value Of Quanex Building Products Corporation (NYSE:NX)

By
Simply Wall St
Published
November 17, 2020

In this article we are going to estimate the intrinsic value of Quanex Building Products Corporation (NYSE:NX) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

View our latest analysis for Quanex Building Products

### 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. 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) forecast

 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Levered FCF (\$, Millions) US\$53.0m US\$51.3m US\$50.5m US\$50.3m US\$50.5m US\$50.9m US\$51.6m US\$52.4m US\$53.3m US\$54.3m Growth Rate Estimate Source Analyst x2 Est @ -3.22% Est @ -1.59% Est @ -0.44% Est @ 0.36% Est @ 0.91% Est @ 1.31% Est @ 1.58% Est @ 1.77% Est @ 1.91% Present Value (\$, Millions) Discounted @ 10% US\$48.1 US\$42.3 US\$37.8 US\$34.2 US\$31.1 US\$28.5 US\$26.2 US\$24.2 US\$22.4 US\$20.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US\$315m

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 (2.2%) 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 10%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US\$54m× (1 + 2.2%) ÷ (10%– 2.2%) = US\$701m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US\$701m÷ ( 1 + 10%)10= US\$267m

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\$582m. 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\$20.6, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

### 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 Quanex Building Products 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 10%, which is based on a levered beta of 1.318. 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.

### Moving On:

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. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Quanex Building Products, we've put together three relevant factors you should assess:

1. Risks: For example, we've discovered 2 warning signs for Quanex Building Products (1 can't be ignored!) that you should be aware of before investing here.
2. Future Earnings: How does NX'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.
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. 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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This article by Simply Wall St is general in nature. 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.
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