U.S. markets open in 6 hours 42 minutes
  • S&P Futures

    4,241.50
    +10.00 (+0.24%)
     
  • Dow Futures

    33,858.00
    +99.00 (+0.29%)
     
  • Nasdaq Futures

    14,300.00
    +37.00 (+0.26%)
     
  • Russell 2000 Futures

    2,309.00
    +8.70 (+0.38%)
     
  • Crude Oil

    73.37
    +0.29 (+0.40%)
     
  • Gold

    1,777.20
    -6.20 (-0.35%)
     
  • Silver

    25.97
    -0.15 (-0.56%)
     
  • EUR/USD

    1.1936
    +0.0003 (+0.02%)
     
  • 10-Yr Bond

    1.4870
    0.0000 (0.00%)
     
  • Vix

    16.32
    -0.34 (-2.04%)
     
  • GBP/USD

    1.3958
    -0.0006 (-0.04%)
     
  • USD/JPY

    110.8490
    -0.1130 (-0.10%)
     
  • BTC-USD

    33,010.70
    -906.59 (-2.67%)
     
  • CMC Crypto 200

    796.45
    -13.74 (-1.70%)
     
  • FTSE 100

    7,074.06
    -15.95 (-0.22%)
     
  • Nikkei 225

    28,875.23
    +0.34 (+0.00%)
     

Are Investors Undervaluing L3Harris Technologies, Inc. (NYSE:LHX) By 34%?

  • Oops!
    Something went wrong.
    Please try again later.
·6 min read
  • Oops!
    Something went wrong.
    Please try again later.

Does the March share price for L3Harris Technologies, Inc. (NYSE:LHX) 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. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for L3Harris Technologies

Step by step through the calculation

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. 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.

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) estimate

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

Levered FCF ($, Millions)

US$2.87b

US$3.10b

US$3.20b

US$3.40b

US$3.48b

US$3.55b

US$3.62b

US$3.70b

US$3.77b

US$3.85b

Growth Rate Estimate Source

Analyst x9

Analyst x9

Analyst x7

Analyst x2

Analyst x2

Est @ 2.06%

Est @ 2.06%

Est @ 2.05%

Est @ 2.05%

Est @ 2.05%

Present Value ($, Millions) Discounted @ 7.3%

US$2.7k

US$2.7k

US$2.6k

US$2.6k

US$2.4k

US$2.3k

US$2.2k

US$2.1k

US$2.0k

US$1.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$23b

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 (2.0%) 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 7.3%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$3.8b× (1 + 2.0%) ÷ (7.3%– 2.0%) = US$74b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$74b÷ ( 1 + 7.3%)10= US$36b

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$60b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$192, the company appears quite undervalued at a 34% 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.

dcf
dcf

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 L3Harris Technologies 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 7.3%, which is based on a levered beta of 1.015. 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:

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. 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. Can we work out why the company is trading at a discount to intrinsic value? For L3Harris Technologies, we've put together three pertinent items you should assess:

  1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with L3Harris Technologies .

  2. Future Earnings: How does LHX'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.

This article by Simply Wall St is general in nature. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.