A look at the fair value of Murphy USA Inc. (NYSE: MUSA)
Today we’re going to do a simple walkthrough of a valuation method used to estimate the attractiveness of Murphy USA Inc. (NYSE:MUSA) as an investment opportunity by taking cash flow the company’s expected future and discounting it to today’s value. We will use the Discounted Cash Flow (DCF) model for this purpose. Don’t be put off by the jargon, the underlying calculations are actually quite simple.
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF ($, millions)||$240.9 million||$313.4 million||$349.3 million||$388.4 million||$417.2 million||$441.3 million||$461.7 million||$479.3 million||$494.9 million||$509.0 million|
|Growth rate estimate Source||Analyst x2||Analyst x1||Analyst x1||Analyst x1||Is at 7.41%||Is at 5.77%||Is at 4.62%||Is at 3.82%||Is at 3.25%||Is at 2.86%|
|Present value (millions of dollars) discounted at 7.0%||$225||$274||$285||$297||$298||$295||$288||$280||$270||$260|
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.9%. We discount terminal cash flows to present value at a cost of equity of 7.0%.
Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = $509 million × (1 + 1.9%) ÷ (7.0%–1.9%) = $10 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $10 billion ÷ (1 + 7.0%)ten= $5.3 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $8.0 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $299, the company appears to be about fair value at a 13% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Murphy USA 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 factors in debt. In this calculation, we used 7.0%, which is based on a leveraged beta of 1.186. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Although a business valuation is important, it is only one of the many factors you need to assess for a business. The DCF model is not a perfect stock valuation tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Murphy USA, there are three relevant items you should consider:
- Risks: Take for example the ubiquitous specter of investment risk. We have identified 3 warning signs with Murphy USA (at least 1, which is a little nasty), and understanding them should be part of your investment process.
- Future earnings: How does MUSA’s growth rate compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every US stock daily, so if you want to find the intrinsic value of any other stock, do a search here.
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