Stock Analysis

An Intrinsic Calculation For HNI Corporation (NYSE:HNI) Suggests It's 45% Undervalued

NYSE:HNI
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Key Insights

  • HNI's estimated fair value is US$54.4 based on 2 Stage Free Cash Flow to Equity
  • Current share price of US$29.7 suggests HNI is 45% undervalued
  • Analyst price target for HNI is US$35.33 which is 35% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of HNI Corporation (NYSE:HNI) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for HNI

Is HNI Fairly Valued?

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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$100.6m US$115.5m US$126.4m US$135.5m US$143.1m US$149.6m US$155.3m US$160.3m US$164.9m US$169.2m
Growth Rate Estimate Source Analyst x2 Analyst x1 Est @ 9.44% Est @ 7.20% Est @ 5.63% Est @ 4.54% Est @ 3.77% Est @ 3.23% Est @ 2.86% Est @ 2.59%
Present Value ($, Millions) Discounted @ 8.0% US$93.2 US$99.0 US$100 US$99.6 US$97.4 US$94.3 US$90.6 US$86.6 US$82.5 US$78.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$922m

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 (2.0%) 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 8.0%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$169m× (1 + 2.0%) ÷ (8.0%– 2.0%) = US$2.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.9b÷ ( 1 + 8.0%)10= US$1.3b

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$2.3b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$29.7, the company appears quite good value at a 45% 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.

dcf
NYSE:HNI Discounted Cash Flow January 9th 2023

The Assumptions

Now 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 HNI 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 8.0%, which is based on a levered beta of 1.001. 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 HNI

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is not viewed as a risk.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Commercial Services market.
Opportunity
  • Trading below our estimate of fair value by more than 20%.
Threat
  • Dividends are not covered by cash flow.
  • Annual earnings are forecast to decline for the next 3 years.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize 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. 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. What is the reason for the share price sitting below the intrinsic value? For HNI, there are three further items you should assess:

  1. Risks: You should be aware of the 3 warning signs for HNI (1 is significant!) we've uncovered before considering an investment in the company.
  2. Future Earnings: How does HNI'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 helping make it simple.

Find out whether HNI is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.