Is Kellanova (NYSE:K) Trading At A 49% Discount?
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Kellanova fair value estimate is US$112
Current share price of US$57.29 suggests Kellanova is potentially 49% undervalued
The US$59.58 analyst price target for K is 47% less than our estimate of fair value
How far off is Kellanova (NYSE:K) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Check out our latest analysis for Kellanova
Is Kellanova Fairly Valued?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$992.0m | US$1.22b | US$1.34b | US$1.43b | US$1.50b | US$1.57b | US$1.63b | US$1.68b | US$1.73b | US$1.78b |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Analyst x1 | Est @ 6.62% | Est @ 5.32% | Est @ 4.41% | Est @ 3.77% | Est @ 3.33% | Est @ 3.02% | Est @ 2.80% |
Present Value ($, Millions) Discounted @ 6.0% | US$936 | US$1.1k | US$1.1k | US$1.1k | US$1.1k | US$1.1k | US$1.1k | US$1.1k | US$1.0k | US$998 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$11b
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 (2.3%) 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 6.0%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$1.8b× (1 + 2.3%) ÷ (6.0%– 2.3%) = US$50b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$50b÷ ( 1 + 6.0%)10= US$28b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$38b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$57.3, the company appears quite undervalued at a 49% 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
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 Kellanova 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 6.0%, which is based on a levered beta of 0.800. 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 Kellanova
Strength
Earnings growth over the past year exceeded its 5-year average.
Debt is well covered by earnings and cashflows.
Weakness
Earnings growth over the past year underperformed the Food industry.
Dividend is low compared to the top 25% of dividend payers in the Food market.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Trading below our estimate of fair value by more than 20%.
Threat
Dividends are not covered by earnings.
Annual earnings are forecast to grow slower than the American market.
Looking Ahead:
Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Kellanova, we've compiled three important items you should further research:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Kellanova , and understanding them should be part of your investment process.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for K'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. 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.
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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.
