Calculating The Fair Value Of REX American Resources Corporation (NYSE:REX)

Key Insights

• The projected fair value for REX American Resources is US$48.67 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$39.94 suggests REX American Resources is potentially trading close to its fair value
• Industry average discount to fair value of 9.1% suggests REX American Resources' peers are currently trading at a lower discount

In this article we are going to estimate the intrinsic value of REX American Resources Corporation (NYSE:REX) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for REX American Resources

The Calculation

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. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$49.9m	US$50.6m	US$51.4m	US$52.4m	US$53.4m	US$54.4m	US$55.5m	US$56.7m	US$57.9m	US$59.1m
Growth Rate Estimate Source	Est @ 1.16%	Est @ 1.46%	Est @ 1.67%	Est @ 1.81%	Est @ 1.91%	Est @ 1.98%	Est @ 2.03%	Est @ 2.07%	Est @ 2.09%	Est @ 2.11%
Present Value ($, Millions) Discounted @ 7.9%	US$46.2	US$43.4	US$40.9	US$38.6	US$36.4	US$34.4	US$32.5	US$30.8	US$29.1	US$27.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$360m

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. 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$59m× (1 + 2.2%) ÷ (7.9%– 2.2%) = US$1.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.0b÷ ( 1 + 7.9%)¹⁰= US$486m

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$846m. 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$39.9, the company appears about fair value at a 18% 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.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 REX American Resources 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 7.9%, which is based on a levered beta of 1.157. 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 REX American Resources

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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. For REX American Resources, we've compiled three further aspects you should consider:

1. Risks: For instance, we've identified 2 warning signs for REX American Resources that you should be aware of.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for REX's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. 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.