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Quaker Chemical Corporation's (NYSE:KWR) Intrinsic Value Is Potentially 27% Above Its Share Price
Key Insights
- The projected fair value for Quaker Chemical is US$238 based on 2 Stage Free Cash Flow to Equity
- Quaker Chemical is estimated to be 21% undervalued based on current share price of US$188
- Analyst price target for KWR is US$230 which is 3.5% below our fair value estimate
Today we will run through one way of estimating the intrinsic value of Quaker Chemical Corporation (NYSE:KWR) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for Quaker Chemical
Is Quaker Chemical Fairly Valued?
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF ($, Millions) | US$165.9m | US$154.1m | US$200.0m | US$234.6m | US$264.6m | US$289.9m | US$311.1m | US$329.1m | US$344.4m | US$357.9m |
Growth Rate Estimate Source | Analyst x2 | Analyst x3 | Analyst x1 | Est @ 17.32% | Est @ 12.76% | Est @ 9.57% | Est @ 7.33% | Est @ 5.76% | Est @ 4.67% | Est @ 3.90% |
Present Value ($, Millions) Discounted @ 8.3% | US$153 | US$131 | US$157 | US$170 | US$177 | US$179 | US$178 | US$173 | US$167 | US$161 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.6b
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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 8.3%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$358m× (1 + 2.1%) ÷ (8.3%– 2.1%) = US$5.9b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$5.9b÷ ( 1 + 8.3%)10= US$2.6b
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$4.3b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$188, the company appears a touch undervalued at a 21% 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. 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 Quaker Chemical 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 8.3%, which is based on a levered beta of 1.050. 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 Quaker Chemical
- Debt is well covered by earnings.
- Dividend is low compared to the top 25% of dividend payers in the Chemicals market.
- Expected to breakeven next year.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Trading below our estimate of fair value by more than 20%.
- Debt is not well covered by operating cash flow.
- Paying a dividend but company is unprofitable.
Moving On:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Quaker Chemical, we've put together three pertinent factors you should consider:
- Risks: Be aware that Quaker Chemical is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for KWR's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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.
Valuation is complex, but we're here to simplify it.
Discover if Quaker Chemical might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.
About NYSE:KWR
Quaker Chemical
Quaker Chemical Corporation, doing business as Quaker Houghton, provides industrial process fluids for steel, aluminum, automotive, aerospace, offshore, can, mining, and metalworking companies worldwide.
Flawless balance sheet, undervalued and pays a dividend.