Key Insights
- AutoZone's estimated fair value is US$2.4k based on 2 Stage Free Cash Flow to Equity
- Current share price of US$2.4k suggests AutoZone is trading close to its fair value
- Analyst price target for AZO is US$2,597 which is 9.4% above our fair value estimate
Today we will run through one way of estimating the intrinsic value of AutoZone, Inc. (NYSE:AZO) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
View our latest analysis for AutoZone
What's The Estimated Valuation?
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF ($, Millions) | US$2.49b | US$2.55b | US$2.80b | US$2.89b | US$3.06b | US$3.18b | US$3.29b | US$3.39b | US$3.48b | US$3.57b |
Growth Rate Estimate Source | Analyst x5 | Analyst x5 | Analyst x3 | Analyst x1 | Analyst x1 | Est @ 4.10% | Est @ 3.47% | Est @ 3.02% | Est @ 2.71% | Est @ 2.49% |
Present Value ($, Millions) Discounted @ 8.5% | US$2.3k | US$2.2k | US$2.2k | US$2.1k | US$2.0k | US$2.0k | US$1.9k | US$1.8k | US$1.7k | US$1.6k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$20b
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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 8.5%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$3.6b× (1 + 2.0%) ÷ (8.5%– 2.0%) = US$56b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$56b÷ ( 1 + 8.5%)10= US$25b
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$45b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$2.4k, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 AutoZone 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 8.5%, which is based on a levered beta of 1.078. 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 AutoZone
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings and cashflows.
- Earnings growth over the past year is below its 5-year average.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow for the next 3 years.
- Total liabilities exceed total assets, which raises the risk of financial distress.
- Annual earnings are forecast to grow slower than the American market.
Looking Ahead:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For AutoZone, we've put together three pertinent factors you should look at:
- Risks: For example, we've discovered 3 warning signs for AutoZone that you should be aware of before investing here.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AZO'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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.
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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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:AZO
AutoZone
AutoZone, Inc. retails and distributes automotive replacement parts and accessories in the United States, Mexico, and Brazil.
Acceptable track record and slightly overvalued.