Does the share price for Itron Inc (NASDAQ:ITRI) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by projecting its future cash flows and then discounting them to today’s value. I will be using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in October 2018 so be sure check out the updated calculation by following the link below.
Step by step through the calculation
I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
|Levered FCF ($, Millions)||$304.27||$310.82||$315.61||$320.48||$325.42|
|Source||Analyst x2||Analyst x2||Est @ 1.54%||Est @ 1.54%||Est @ 1.54%|
|Present Value Discounted @ 12.77%||$269.81||$244.41||$220.08||$198.17||$178.44|
Present Value of 5-year Cash Flow (PVCF)= US$1.11b
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 12.8%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$325.4m × (1 + 2.9%) ÷ (12.8% – 2.9%) = US$3.41b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$3.41b ÷ ( 1 + 12.8%)5 = US$1.87b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$2.98b. 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 $75.87. Compared to the current share price of $64.2, the stock is about right, perhaps slightly undervalued at a 15.4% discount to what it is available for right now.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Itron 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 12.8%, which is based on a levered beta of 1.393. 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.
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For ITRI, there are three relevant aspects you should look at:
- Financial Health: Does ITRI 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 ITRI’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 ITRI? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
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 email@example.com.