Is Itron, Inc. (NASDAQ:ITRI) Trading At A 34% Discount?
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Itron fair value estimate is US$101
Itron is estimated to be 34% undervalued based on current share price of US$66.03
The US$78.25 analyst price target for ITRI is 22% less than our estimate of fair value
In this article we are going to estimate the intrinsic value of Itron, Inc. (NASDAQ:ITRI) by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for Itron
The Method
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$137.5m | US$182.4m | US$216.7m | US$246.6m | US$272.1m | US$293.6m | US$311.8m | US$327.4m | US$341.0m | US$353.3m |
Growth Rate Estimate Source | Analyst x6 | Analyst x5 | Est @ 18.78% | Est @ 13.81% | Est @ 10.34% | Est @ 7.90% | Est @ 6.20% | Est @ 5.00% | Est @ 4.17% | Est @ 3.58% |
Present Value ($, Millions) Discounted @ 8.0% | US$127 | US$156 | US$172 | US$181 | US$185 | US$185 | US$182 | US$177 | US$170 | US$163 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.7b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.2%) 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 8.0%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$353m× (1 + 2.2%) ÷ (8.0%– 2.2%) = US$6.2b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$6.2b÷ ( 1 + 8.0%)10= US$2.9b
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$4.6b. 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$66.0, 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.
Important Assumptions
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 Itron 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 8.0%, which is based on a levered beta of 1.161. 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 Itron
Strength
Debt is well covered by earnings.
Weakness
No major weaknesses identified for ITRI.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Trading below our estimate of fair value by more than 20%.
Threat
Debt is not well covered by operating cash flow.
Annual revenue is forecast to grow slower than the American market.
Looking Ahead:
Although the valuation of a company is important, it is only one of many factors that you need to assess for 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. 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. Why is the intrinsic value higher than the current share price? For Itron, we've put together three important aspects you should further examine:
Risks: Every company has them, and we've spotted 1 warning sign for Itron you should know about.
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: 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.
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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.
