Stock Analysis

# An Intrinsic Calculation For Baxter International Inc. (NYSE:BAX) Suggests It's 23% Undervalued

•  Updated

How far off is Baxter International Inc. (NYSE:BAX) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Baxter International

### 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. To start off with, we need to estimate 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, and so the sum of these future cash flows is then discounted to today's value:

#### 10-year free cash flow (FCF) estimate

 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Levered FCF (\$, Millions) US\$1.78b US\$1.95b US\$2.20b US\$2.36b US\$2.52b US\$2.63b US\$2.74b US\$2.83b US\$2.91b US\$2.98b Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x3 Analyst x1 Analyst x1 Est @ 4.67% Est @ 3.86% Est @ 3.3% Est @ 2.91% Est @ 2.63% Present Value (\$, Millions) Discounted @ 6.4% US\$1.7k US\$1.7k US\$1.8k US\$1.8k US\$1.8k US\$1.8k US\$1.8k US\$1.7k US\$1.7k US\$1.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US\$17b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 6.4%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US\$3.0b× (1 + 2.0%) ÷ (6.4%– 2.0%) = US\$68b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US\$68b÷ ( 1 + 6.4%)10= US\$37b

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\$54b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US\$82.2, the company appears a touch undervalued at a 23% 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.

### Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Baxter International 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 6.4%, which is based on a levered beta of 0.945. 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.

### Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. Why is the intrinsic value higher than the current share price? For Baxter International, we've put together three pertinent elements you should consider:

1. Risks: As an example, we've found 3 warning signs for Baxter International that you need to consider before investing here.
2. Future Earnings: How does BAX'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.

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### Valuation is complex, but we're helping make it simple.

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#### Baxter International

Baxter International Inc., through its subsidiaries, develops and provides a portfolio of healthcare products worldwide.

Very undervalued with reasonable growth potential.