Amphenol Corporation's (NYSE:APH) Intrinsic Value Is Potentially 26% Below Its Share Price
- Using the 2 Stage Free Cash Flow to Equity, Amphenol fair value estimate is US$56.54
- Amphenol is estimated to be 35% overvalued based on current share price of US$76.25
- The US$87.60 analyst price target for APH is 55% more than our estimate of fair value
In this article we are going to estimate the intrinsic value of Amphenol Corporation (NYSE:APH) by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
View our latest analysis for Amphenol
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||US$1.90b||US$2.02b||US$2.16b||US$2.31b||US$2.43b||US$2.52b||US$2.61b||US$2.68b||US$2.76b||US$2.83b|
|Growth Rate Estimate Source||Analyst x8||Analyst x6||Analyst x2||Analyst x1||Analyst x1||Est @ 3.92%||Est @ 3.36%||Est @ 2.97%||Est @ 2.70%||Est @ 2.51%|
|Present Value ($, Millions) Discounted @ 8.8%||US$1.7k||US$1.7k||US$1.7k||US$1.6k||US$1.6k||US$1.5k||US$1.4k||US$1.4k||US$1.3k||US$1.2k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$15b
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 8.8%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$2.8b× (1 + 2.1%) ÷ (8.8%– 2.1%) = US$43b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$43b÷ ( 1 + 8.8%)10= US$18b
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$34b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$76.3, 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Amphenol 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 8.8%, which is based on a levered beta of 1.134. 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 Amphenol
- Earnings growth over the past year exceeded its 5-year average.
- Debt is well covered by earnings and cashflows.
- Dividends are covered by earnings and cash flows.
- Earnings growth over the past year underperformed the Electronic industry.
- Dividend is low compared to the top 25% of dividend payers in the Electronic market.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow for the next 3 years.
- Annual earnings are forecast to grow slower than the American market.
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a premium to intrinsic value? For Amphenol, we've compiled three fundamental aspects you should look at:
- Risks: To that end, you should be aware of the 1 warning sign we've spotted with Amphenol .
- Future Earnings: How does APH'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: 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 NYSE every day. If you want to find the calculation for other stocks just search here.
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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.
Amphenol Corporation, together with its subsidiaries, primarily designs, manufactures, and markets electrical, electronic, and fiber optic connectors in the United States, China, and internationally.
Outstanding track record with excellent balance sheet and pays a dividend.