Today we will run through one way of estimating the intrinsic value of Resideo Technologies, Inc. (NYSE:REZI) 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. There's really not all that much to it, even though it might appear quite complex.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.
Our analysis indicates that REZI is potentially undervalued!
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 begin with, we have to get estimates of 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 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$305.0m||US$342.0m||US$369.2m||US$391.9m||US$411.1m||US$427.7m||US$442.2m||US$455.4m||US$467.6m||US$479.2m|
|Growth Rate Estimate Source||Analyst x1||Analyst x1||Est @ 7.94%||Est @ 6.15%||Est @ 4.9%||Est @ 4.03%||Est @ 3.41%||Est @ 2.98%||Est @ 2.68%||Est @ 2.47%|
|Present Value ($, Millions) Discounted @ 8.1%||US$282||US$293||US$293||US$287||US$279||US$269||US$257||US$245||US$233||US$221|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.7b
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 (2.0%) 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 8.1%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$479m× (1 + 2.0%) ÷ (8.1%– 2.0%) = US$8.0b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$8.0b÷ ( 1 + 8.1%)10= US$3.7b
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$6.4b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$21.8, the company appears quite good value at a 50% 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Resideo Technologies 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 8.1%, which is based on a levered beta of 1.300. 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 Resideo Technologies
- Debt is well covered by earnings.
- Earnings growth over the past year underperformed the Building industry.
- 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 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Resideo Technologies, there are three further factors you should further research:
- Risks: For instance, we've identified 1 warning sign for Resideo Technologies that you should be aware of.
- Future Earnings: How does REZI'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. 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. 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.
Resideo Technologies, Inc. develops, manufactures, and sells comfort, residential thermal, and security solutions to the commercial and residential end markets in the United States, Europe, and internationally.
Very undervalued with mediocre balance sheet.