Stock Analysis

Are O'Reilly Automotive, Inc. (NASDAQ:ORLY) Investors Paying Above The Intrinsic Value?

NasdaqGS:ORLY
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Key Insights

  • O'Reilly Automotive's estimated fair value is US$679 based on 2 Stage Free Cash Flow to Equity
  • O'Reilly Automotive's US$907 share price signals that it might be 33% overvalued
  • The US$963 analyst price target for ORLY is 42% more than our estimate of fair value

How far off is O'Reilly Automotive, Inc. (NASDAQ:ORLY) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present 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!

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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for O'Reilly Automotive

Crunching The Numbers

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$2.10b US$2.31b US$2.52b US$2.54b US$2.70b US$2.80b US$2.90b US$2.99b US$3.07b US$3.15b
Growth Rate Estimate Source Analyst x6 Analyst x5 Analyst x3 Analyst x1 Analyst x1 Est @ 3.92% Est @ 3.38% Est @ 3.00% Est @ 2.73% Est @ 2.54%
Present Value ($, Millions) Discounted @ 8.2% US$1.9k US$2.0k US$2.0k US$1.9k US$1.8k US$1.7k US$1.7k US$1.6k US$1.5k US$1.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$18b

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 8.2%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$3.1b× (1 + 2.1%) ÷ (8.2%– 2.1%) = US$53b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$53b÷ ( 1 + 8.2%)10= US$24b

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$41b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$907, the company appears reasonably expensive 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.

dcf
NasdaqGS:ORLY Discounted Cash Flow June 10th 2023

The Assumptions

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 these result, have a go at the calculation yourself and play with the 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 O'Reilly Automotive 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 8.2%, which is based on a levered beta of 1.028. 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 O'Reilly Automotive

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
Weakness
  • Earnings growth over the past year is below its 5-year average.
  • Expensive based on P/E ratio and estimated fair value.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
Threat
  • Total liabilities exceed total assets, which raises the risk of financial distress.
  • Annual earnings are forecast to grow slower than the American market.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value lower than the current share price? For O'Reilly Automotive, we've put together three important aspects you should assess:

  1. Risks: You should be aware of the 3 warning signs for O'Reilly Automotive (1 is potentially serious!) we've uncovered before considering an investment in the company.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ORLY's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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 NASDAQGS every day. If you want to find the calculation for other stocks just search here.

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

Find out whether O'Reilly Automotive is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis

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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.