In this article I am going to calculate the intrinsic value of Kohl's Corporation (NYSE:KSS) by taking the foreast future cash flows of the company and discounting them back 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in July 2018 so be sure check out the updated calculation by following the link below.
Check out our latest analysis for Kohl's
The method
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. Where possible I use analyst estimates, but when these aren't available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow estimate
| 2018 | 2019 | 2020 | 2021 | 2022 | |
| Levered FCF ($, Millions) | $1.09k | $1.40k | $1.23k | $1.28k | $1.27k |
| Source | Analyst x8 | Analyst x6 | Analyst x5 | Analyst x1 | Extrapolated @ (-0.23%) |
| Present Value Discounted @ 8.59% | $1.01k | $1.18k | $956.99 | $916.96 | $842.51 |
Present Value of 5-year Cash Flow (PVCF)= US$4.91b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. 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 8.6%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$1.27b × (1 + 2.9%) ÷ (8.6% – 2.9%) = US$23.22b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$23.22b ÷ ( 1 + 8.6%)5 = US$15.38b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$20.29b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of $121.41. Relative to the current share price of $73.65, the stock is quite undervalued at a 39.34% discount to what it is available for right now.
The assumptions
I'd like to point out that 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 Kohl's 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 8.6%, which is based on a levered beta of 0.800. 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:
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 KSS, there are three important aspects you should further examine:
- Financial Health: Does KSS 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 KSS'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 KSS? 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.
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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 editorial-team@simplywallst.com.
Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.