Is Cabot Corporation (NYSE:CBT) Expensive For A Reason? A Look At Its Intrinsic Value

Key Insights

• Cabot's estimated fair value is US$49.48 based on 2 Stage Free Cash Flow to Equity

• Cabot's US$64.56 share price signals that it might be 30% overvalued

• The US$86.17 analyst price target for CBT is 74% more than our estimate of fair value

Does the June share price for Cabot Corporation (NYSE:CBT) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. Our analysis will employ 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.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Cabot

Step By Step Through The Calculation

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. 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$258.8m	US$307.5m	US$252.3m	US$221.9m	US$204.5m	US$194.7m	US$189.3m	US$186.8m	US$186.3m	US$187.2m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x3	Est @ -12.07%	Est @ -7.81%	Est @ -4.84%	Est @ -2.75%	Est @ -1.29%	Est @ -0.27%	Est @ 0.44%
Present Value ($, Millions) Discounted @ 8.6%	US$238	US$261	US$197	US$160	US$135	US$119	US$106	US$96.7	US$88.8	US$82.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.5b

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. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.1%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.6%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$187m× (1 + 2.1%) ÷ (8.6%– 2.1%) = US$2.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$2.9b÷ ( 1 + 8.6%)¹⁰= US$1.3b

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$2.8b. 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$64.6, the company appears potentially overvalued 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

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Cabot 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 8.6%, which is based on a levered beta of 1.091. 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 Cabot

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is well covered by earnings and cashflows.

• Dividends are covered by earnings and cash flows.

Weakness

• Dividend is low compared to the top 25% of dividend payers in the Chemicals market.

Opportunity

• Annual earnings are forecast to grow for the next 3 years.

• Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

• Annual earnings are forecast to grow slower than the American market.

Next Steps:

Whilst important, the DCF calculation 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price exceeding the intrinsic value? For Cabot, we've put together three important elements you should explore:

1. Risks: We feel that you should assess the 1 warning sign for Cabot we've flagged before making an investment in the company.

2. Future Earnings: How does CBT'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 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. 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.

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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here