A Look At The Intrinsic Value Of Air Products and Chemicals, Inc. (NYSE:APD)

Key Insights

• The projected fair value for Air Products and Chemicals is US$240 based on 2 Stage Free Cash Flow to Equity
• With US$274 share price, Air Products and Chemicals appears to be trading close to its estimated fair value
• Our fair value estimate is 25% lower than Air Products and Chemicals' analyst price target of US$320

Does the May share price for Air Products and Chemicals, Inc. (NYSE:APD) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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Is Air Products and Chemicals 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. 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.

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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	-US$1.73b	US$499.8m	US$1.17b	US$2.24b	US$2.59b	US$2.85b	US$3.08b	US$3.28b	US$3.45b	US$3.61b
Growth Rate Estimate Source	Analyst x9	Analyst x9	Analyst x7	Analyst x2	Analyst x1	Est @ 10.23%	Est @ 7.98%	Est @ 6.41%	Est @ 5.31%	Est @ 4.54%
Present Value ($, Millions) Discounted @ 7.3%	-US$1.6k	US$435	US$946	US$1.7k	US$1.8k	US$1.9k	US$1.9k	US$1.9k	US$1.8k	US$1.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$13b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$3.6b× (1 + 2.8%) ÷ (7.3%– 2.8%) = US$82b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$82b÷ ( 1 + 7.3%)¹⁰= US$41b

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$53b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$274, the company appears around fair value at the time of writing. 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. 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 Air Products and Chemicals 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 7.3%, which is based on a levered beta of 1.040. 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.

Check out our latest analysis for Air Products and Chemicals

SWOT Analysis for Air Products and Chemicals

Next Steps:

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. For Air Products and Chemicals, we've compiled three important elements you should further research:

1. Risks: You should be aware of the 5 warning signs for Air Products and Chemicals (2 are potentially serious!) we've uncovered before considering an investment in the company.
2. Future Earnings: How does APD'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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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.