I am going to run you through how I calculated the intrinsic value of Greif, Inc. (NYSE:GEF) by estimating the company’s future cash flows and discounting them to their present value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! 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. If you are reading this and its not December 2018 then I highly recommend you check out the latest calculation for Greif by following the link below.
Is GEF fairly valued?
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 begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
|Levered FCF ($, Millions)||$186.95||$218.53||$211.34||$204.39||$197.67|
|Source||Analyst x4||Analyst x4||Est @ -3.29%||Est @ -3.29%||Est @ -3.29%|
|Present Value Discounted @ 11.72%||$167.34||$175.08||$151.56||$131.20||$113.57|
Present Value of 5-year Cash Flow (PVCF)= US$739m
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 an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 11.7%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$198m × (1 + 2.9%) ÷ (11.7% – 2.9%) = US$2.3b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$2.3b ÷ ( 1 + 11.7%)5 = US$1.3b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$2.1b. 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 $43.21. Compared to the current share price of $33.66, the stock is about right, perhaps slightly undervalued at a 22% discount to what it is available for right now.
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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Greif 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 11.7%, which is based on a levered beta of 1.244. 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.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For GEF, there are three key aspects you should look at:
- Financial Health: Does GEF 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.
- Future Earnings: How does GEF’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of GEF? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
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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 firstname.lastname@example.org.