A Look At The Intrinsic Value Of Lowe's Companies, Inc. (NYSE:LOW)

By
Simply Wall St
Published
November 24, 2021
NYSE:LOW
Source: Shutterstock

Today we will run through one way of estimating the intrinsic value of Lowe's Companies, Inc. (NYSE:LOW) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Lowe's Companies

The model

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$8.10b US$8.68b US$9.30b US$9.86b US$10.5b US$11.0b US$11.4b US$11.8b US$12.2b US$12.5b
Growth Rate Estimate Source Analyst x9 Analyst x9 Analyst x5 Analyst x2 Analyst x2 Est @ 4.73% Est @ 3.9% Est @ 3.32% Est @ 2.91% Est @ 2.63%
Present Value ($, Millions) Discounted @ 7.7% US$7.5k US$7.5k US$7.4k US$7.3k US$7.3k US$7.1k US$6.8k US$6.5k US$6.3k US$6.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$70b

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 7.7%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$12b× (1 + 2.0%) ÷ (7.7%– 2.0%) = US$223b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$223b÷ ( 1 + 7.7%)10= US$106b

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$176b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$252, the company appears about fair value at a 1.9% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
NYSE:LOW Discounted Cash Flow November 24th 2021

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 Lowe's Companies 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 7.7%, which is based on a levered beta of 1.304. 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.

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Lowe's Companies, we've compiled three fundamental factors you should look at:

  1. Risks: Be aware that Lowe's Companies is showing 3 warning signs in our investment analysis , and 1 of those can't be ignored...
  2. Future Earnings: How does LOW'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.
  3. 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.

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