An Intrinsic Calculation For Genesco Inc. (NYSE:GCO) Suggests It's 24% Undervalued
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Genesco fair value estimate is US$33.16
Genesco's US$25.04 share price signals that it might be 24% undervalued
Peers of Genesco are currently trading on average at a 183% premium
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Genesco Inc. (NYSE:GCO) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
View our latest analysis for Genesco
The Calculation
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$84.3m | US$47.3m | US$48.0m | US$48.7m | US$49.5m | US$50.4m | US$51.3m | US$52.3m | US$53.4m | US$54.4m |
Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Est @ 1.47% | Est @ 1.66% | Est @ 1.79% | Est @ 1.89% | Est @ 1.96% | Est @ 2.00% | Est @ 2.03% |
Present Value ($, Millions) Discounted @ 14% | US$74.0 | US$36.4 | US$32.4 | US$28.8 | US$25.7 | US$23.0 | US$20.5 | US$18.3 | US$16.4 | US$14.7 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$290m
The second stage is also known as Terminal Value, this is the business's cash flow after 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 14%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$54m× (1 + 2.1%) ÷ (14%– 2.1%) = US$468m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$468m÷ ( 1 + 14%)10= US$126m
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$417m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$25.0, the company appears a touch undervalued at a 24% discount to where the stock price trades currently. 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 Assumptions
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 these result, have a go at the calculation yourself and play with the 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 Genesco 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 14%, which is based on a levered beta of 2.000. 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 Genesco
Strength
Debt is well covered by earnings.
Weakness
Earnings declined over the past year.
Opportunity
Trading below our estimate of fair value by more than 20%.
Significant insider buying over the past 3 months.
Threat
Debt is not well covered by operating cash flow.
Moving On:
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. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Genesco, there are three important elements you should assess:
Risks: Case in point, we've spotted 3 warning signs for Genesco you should be aware of, and 1 of them doesn't sit too well with us.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for GCO's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.
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