- United States
Estimating The Intrinsic Value Of Pentair plc (NYSE:PNR)
- Using the 2 Stage Free Cash Flow to Equity, Pentair fair value estimate is US$57.00
- With US$52.23 share price, Pentair appears to be trading close to its estimated fair value
- Our fair value estimate is 4.2% higher than Pentair's analyst price target of US$59.38
Does the March share price for Pentair plc (NYSE:PNR) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Check out our latest analysis for Pentair
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
|Levered FCF ($, Millions)||US$606.7m||US$700.6m||US$755.3m||US$786.1m||US$811.3m||US$834.5m||US$856.4m||US$877.4m||US$898.0m||US$918.3m|
|Growth Rate Estimate Source||Analyst x7||Analyst x6||Analyst x2||Analyst x1||Est @ 3.20%||Est @ 2.86%||Est @ 2.62%||Est @ 2.46%||Est @ 2.34%||Est @ 2.26%|
|Present Value ($, Millions) Discounted @ 10.0%||US$552||US$579||US$568||US$537||US$504||US$472||US$440||US$410||US$382||US$355|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.8b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 10.0%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$918m× (1 + 2.1%) ÷ (10.0%– 2.1%) = US$12b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$12b÷ ( 1 + 10.0%)10= US$4.6b
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$9.4b. 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$52.2, the company appears about fair value at a 8.4% 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.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Pentair 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 10.0%, which is based on a levered beta of 1.134. 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 Pentair
- Debt is well covered by earnings.
- Dividends are covered by earnings and cash flows.
- Earnings declined over the past year.
- 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.
- Good value based on P/E ratio and estimated fair value.
- Debt is not well covered by operating cash flow.
- Annual earnings are forecast to grow slower than the American market.
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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Pentair, we've put together three fundamental items you should further examine:
- Risks: For example, we've discovered 2 warning signs for Pentair (1 can't be ignored!) that you should be aware of before investing here.
- Future Earnings: How does PNR'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. 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.
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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.
Pentair plc provides various water solutions worldwide.
Good value with limited growth.