A Look At The Fair Value Of Avery Dennison Corporation (NYSE:AVY)

Does the December share price for Avery Dennison Corporation (NYSE:AVY) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by projecting its future cash flows and then discounting them to today’s value. This is done using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in December 2018 so be sure check out the updated calculation by following the link below.

Check out our latest analysis for Avery Dennison

The model

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 five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.

5-year cash flow estimate

2019 2020 2021 2022 2023
Levered FCF ($, Millions) $539.81 $634.35 $648.21 $662.38 $676.85
Source Analyst x7 Analyst x4 Est @ 2.19% Est @ 2.19% Est @ 2.19%
Present Value Discounted @ 10.45% $488.74 $520.00 $481.09 $445.09 $411.79

Present Value of 5-year Cash Flow (PVCF)= US$2.3b

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 the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 10.4%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$677m × (1 + 2.9%) ÷ (10.4% – 2.9%) = US$9.3b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$9.3b ÷ ( 1 + 10.4%)5 = US$5.7b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$8.0b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $92.26. Compared to the current share price of $91.17, the stock is about right, perhaps slightly undervalued at a 1.2% discount to what it is available for right now.

NYSE:AVY Intrinsic Value Export December 11th 18
NYSE:AVY Intrinsic Value Export December 11th 18

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Avery Dennison as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 10.4%, which is based on a levered beta of 1.064. This is derived from the Bottom-Up Beta method based on 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 shouldn’t be the only metric you look at when researching a company. For AVY, there are three important factors you should further research:

  1. Financial Health: Does AVY have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does AVY’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: Are there other high quality stocks you could be holding instead of AVY? 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 for every stock on the NYSE every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.