A Look At The Fair Value Of Standard Motor Products, Inc. (NYSE:SMP)

In this article:

Key Insights

  • The projected fair value for Standard Motor Products is US$34.76 based on 2 Stage Free Cash Flow to Equity

  • With US$36.80 share price, Standard Motor Products appears to be trading close to its estimated fair value

  • Analyst price target for SMP is US$48.33, which is 39% above our fair value estimate

Does the August share price for Standard Motor Products, Inc. (NYSE:SMP) 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 their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 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 Standard Motor Products

The Model

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$77.4m

US$74.2m

US$72.5m

US$71.8m

US$71.8m

US$72.2m

US$73.0m

US$74.0m

US$75.2m

US$76.5m

Growth Rate Estimate Source

Est @ -6.80%

Est @ -4.13%

Est @ -2.26%

Est @ -0.95%

Est @ -0.03%

Est @ 0.61%

Est @ 1.06%

Est @ 1.38%

Est @ 1.60%

Est @ 1.75%

Present Value ($, Millions) Discounted @ 11%

US$69.8

US$60.3

US$53.2

US$47.5

US$42.8

US$38.8

US$35.4

US$32.4

US$29.6

US$27.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$437m

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 11%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$76m× (1 + 2.1%) ÷ (11%– 2.1%) = US$890m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$890m÷ ( 1 + 11%)10= US$316m

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$753m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$36.8, the company appears around fair value at the time of writing. 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

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Standard Motor Products 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 11%, which is based on a levered beta of 1.478. 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 Standard Motor Products

Strength

  • Debt is not viewed as a risk.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Earnings declined over the past year.

  • Dividend is low compared to the top 25% of dividend payers in the Auto Components market.

Opportunity

  • Annual earnings are forecast to grow faster than the American market.

  • Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

  • Annual revenue is forecast to grow slower than the American market.

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. For Standard Motor Products, we've compiled three pertinent items you should consider:

  1. Risks: Case in point, we've spotted 2 warning signs for Standard Motor Products you should be aware of.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SMP's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  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. 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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