Stock Analysis

Quanex Building Products Corporation's (NYSE:NX) Intrinsic Value Is Potentially 59% Above Its Share Price

NYSE:NX
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Key Insights

  • Quanex Building Products' estimated fair value is US$38.93 based on 2 Stage Free Cash Flow to Equity
  • Quanex Building Products is estimated to be 37% undervalued based on current share price of US$24.46
  • Our fair value estimate is 18% lower than Quanex Building Products' analyst price target of US$32.00

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Quanex Building Products Corporation (NYSE:NX) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$78.9m US$83.4m US$86.9m US$89.9m US$92.7m US$95.3m US$97.7m US$100.1m US$102.4m US$104.7m
Growth Rate Estimate Source Analyst x2 Analyst x2 Est @ 4.16% Est @ 3.53% Est @ 3.10% Est @ 2.79% Est @ 2.57% Est @ 2.42% Est @ 2.32% Est @ 2.24%
Present Value ($, Millions) Discounted @ 8.7% US$72.6 US$70.6 US$67.6 US$64.4 US$61.1 US$57.8 US$54.5 US$51.4 US$48.3 US$45.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$594m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 8.7%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$105m× (1 + 2.1%) ÷ (8.7%– 2.1%) = US$1.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.6b÷ ( 1 + 8.7%)10= US$700m

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$1.3b. 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$24.5, the company appears quite good value at a 37% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NYSE:NX Discounted Cash Flow March 8th 2023

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. 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 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 8.7%, which is based on a levered beta of 1.116. 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 Quanex Building Products

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Building market.
Opportunity
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Annual earnings are forecast to decline for the next 2 years.

Looking Ahead:

Whilst important, the DCF calculation 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?" 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 Quanex Building Products, we've compiled three additional factors you should consider:

  1. Risks: You should be aware of the 1 warning sign for Quanex Building Products we've uncovered before considering an investment in the company.
  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. 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 here to simplify it.

Discover if Quanex Building Products might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.

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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.