Schnitzer Steel Industries, Inc. (NASDAQ:RDUS) Shares Could Be 40% Below Their Intrinsic Value Estimate
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Schnitzer Steel Industries fair value estimate is US$46.52
Current share price of US$27.84 suggests Schnitzer Steel Industries is potentially 40% undervalued
Peers of Schnitzer Steel Industries are currently trading on average at a 372% premium
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Schnitzer Steel Industries, Inc. (NASDAQ:RDUS) as an investment opportunity 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Check out our latest analysis for Schnitzer Steel Industries
Is Schnitzer Steel Industries 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. 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, 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$41.3m | US$89.0m | US$93.9m | US$98.2m | US$102.0m | US$105.4m | US$108.6m | US$111.6m | US$114.5m | US$117.3m |
Growth Rate Estimate Source | Analyst x2 | Analyst x1 | Est @ 5.53% | Est @ 4.54% | Est @ 3.84% | Est @ 3.36% | Est @ 3.02% | Est @ 2.78% | Est @ 2.61% | Est @ 2.49% |
Present Value ($, Millions) Discounted @ 9.3% | US$37.8 | US$74.5 | US$72.0 | US$68.9 | US$65.5 | US$61.9 | US$58.4 | US$54.9 | US$51.6 | US$48.4 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$594m
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 (2.2%) 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 9.3%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$117m× (1 + 2.2%) ÷ (9.3%– 2.2%) = US$1.7b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.7b÷ ( 1 + 9.3%)10= US$702m
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$1.3b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$27.8, the company appears quite undervalued at a 40% 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
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. 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 Schnitzer Steel Industries 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 9.3%, which is based on a levered beta of 1.409. 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 Schnitzer Steel Industries
Strength
Debt is well covered by cash flow.
Weakness
Interest payments on debt are not well covered.
Dividend is low compared to the top 25% of dividend payers in the Metals and Mining market.
Opportunity
Expected to breakeven next year.
Has sufficient cash runway for more than 3 years based on current free cash flows.
Good value based on P/S ratio and estimated fair value.
Threat
Dividends are not covered by cash flow.
Moving On:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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 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 Schnitzer Steel Industries, there are three relevant factors you should look at:
Risks: Be aware that Schnitzer Steel Industries is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...
Future Earnings: How does RDUS'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 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 NASDAQGS 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.
