Walmart Inc. (NYSE:WMT) Shares Could Be 33% Below Their Intrinsic Value Estimate

August 18, 2022
  •  Updated
October 02, 2022
NYSE:WMT
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In this article we are going to estimate the intrinsic value of Walmart Inc. (NYSE:WMT) 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. It may sound complicated, but actually it is quite simple!

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.

View our latest analysis for Walmart

Step By Step Through The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$14.5b US$15.9b US$17.0b US$19.0b US$20.2b US$21.1b US$21.9b US$22.6b US$23.2b US$23.8b
Growth Rate Estimate Source Analyst x9 Analyst x9 Analyst x5 Analyst x2 Analyst x2 Est @ 4.47% Est @ 3.71% Est @ 3.18% Est @ 2.81% Est @ 2.55%
Present Value ($, Millions) Discounted @ 5.3% US$13.8k US$14.3k US$14.5k US$15.5k US$15.6k US$15.5k US$15.2k US$14.9k US$14.6k US$14.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$148b

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 5.3%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$24b× (1 + 1.9%) ÷ (5.3%– 1.9%) = US$716b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$716b÷ ( 1 + 5.3%)10= US$426b

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$574b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$140, the company appears quite good value at a 33% 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:WMT Discounted Cash Flow August 18th 2022

The Assumptions

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 Walmart 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 5.3%, which is based on a levered beta of 0.800. 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.

Next Steps:

Although the valuation of a company is important, it 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 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 Walmart, there are three important items you should explore:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Walmart , and understanding them should be part of your investment process.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for WMT's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. 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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