Advertisement
U.S. markets open in 1 hour 47 minutes
  • S&P Futures

    5,303.25
    -5.00 (-0.09%)
     
  • Dow Futures

    40,121.00
    -23.00 (-0.06%)
     
  • Nasdaq Futures

    18,480.50
    -23.25 (-0.13%)
     
  • Russell 2000 Futures

    2,139.20
    +0.80 (+0.04%)
     
  • Crude Oil

    82.51
    +1.16 (+1.43%)
     
  • Gold

    2,231.70
    +19.00 (+0.86%)
     
  • Silver

    24.68
    -0.07 (-0.27%)
     
  • EUR/USD

    1.0792
    -0.0037 (-0.35%)
     
  • 10-Yr Bond

    4.1960
    0.0000 (0.00%)
     
  • Vix

    12.98
    +0.20 (+1.56%)
     
  • GBP/USD

    1.2620
    -0.0018 (-0.14%)
     
  • USD/JPY

    151.3840
    +0.1380 (+0.09%)
     
  • Bitcoin USD

    70,559.34
    +318.05 (+0.45%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • FTSE 100

    7,952.37
    +20.39 (+0.26%)
     
  • Nikkei 225

    40,168.07
    -594.66 (-1.46%)
     

Is There An Opportunity With Valvoline Inc.'s (NYSE:VVV) 31% Undervaluation?

Does the December share price for Valvoline Inc. (NYSE:VVV) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. 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 Valvoline

The model

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 begin with, we have to get estimates of 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.

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

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Levered FCF ($, Millions)

US$282.5m

US$371.5m

US$409.9m

US$442.0m

US$468.8m

US$491.4m

US$511.0m

US$528.2m

US$543.7m

US$558.1m

Growth Rate Estimate Source

Analyst x2

Analyst x2

Est @ 10.34%

Est @ 7.82%

Est @ 6.07%

Est @ 4.83%

Est @ 3.97%

Est @ 3.37%

Est @ 2.95%

Est @ 2.65%

Present Value ($, Millions) Discounted @ 6.9%

US$264

US$325

US$336

US$339

US$336

US$330

US$321

US$310

US$299

US$287

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.1b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.9%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$558m× (1 + 2.0%) ÷ (6.9%– 2.0%) = US$12b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$12b÷ ( 1 + 6.9%)10= US$5.9b

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$9.1b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$35.1, the company appears quite good value at a 31% 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

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 Valvoline 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 6.9%, which is based on a levered beta of 1.123. 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.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Valvoline, we've put together three additional items you should assess:

  1. Risks: Be aware that Valvoline is showing 3 warning signs in our investment analysis , and 1 of those is significant...

  2. Future Earnings: How does VVV'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.

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.

Advertisement