Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Caesarstone Ltd (NASDAQ:CSTE) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. I will be using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in October 2018 so be sure check out the updated calculation by following the link below.
Step by step through the calculation
I’m 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 perpetual stable growth rate. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
|Levered FCF ($, Millions)||$41.00||$45.64||$50.80||$56.55||$62.95|
|Source||Analyst x1||Est @ 11.32%||Est @ 11.32%||Est @ 11.32%||Est @ 11.32%|
|Present Value Discounted @ 11.28%||$36.85||$36.86||$36.87||$36.89||$36.90|
Present Value of 5-year Cash Flow (PVCF)= US$184m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 11.3%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$63m × (1 + 2.9%) ÷ (11.3% – 2.9%) = US$778m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$778m ÷ ( 1 + 11.3%)5 = US$456m
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$641m. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $18.65. Compared to the current share price of $17.11, the stock is about right, perhaps slightly undervalued at a 8.3% discount to what it is available for right now.
I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Caesarstone as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 11.3%, which is based on a levered beta of 1.181. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
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. For CSTE, I’ve compiled three pertinent factors you should further examine:
- Financial Health: Does CSTE have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does CSTE’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: Are there other high quality stocks you could be holding instead of CSTE? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
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The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.