A look at the intrinsic value of Brady Corporation (NYSE: BRC)
In this article, we’ll estimate the intrinsic value of Brady Corporation (NYSE: BRC) by projecting its future cash flows and then discounting them to present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There really isn’t much to do, although it might seem quite complex.
Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. Anyone interested in learning a little more about intrinsic value should have a read of the Simply Wall St.
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We use what is called a 2-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. First, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
Typically, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) estimate
|Levered FCF ($, million)||$ 162.0 million||$ 152.8 million||165.2 million USD||164.5 million USD||165.1 million USD||166.4 million USD||$ 168.3 million||$ 170.7 million||173.4 million USD||176.4 million USD|
|Source of estimated growth rate||Analyst x1||Analyst x2||Analyst x2||East @ -0.41%||Is 0.31%||Is 0.81%||Is 1.17%||Is at 1.41%||Is 1.59%||Is at 1.71%|
|Present value ($, millions) discounted at 6.4%||US $ 152||US $ 135||USD 137||US $ 129||121 USD||US $ 115||US $ 109||US $ 104||US $ 99.6||US $ 95.3|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = $ 1.2 billion
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. 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 used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.4%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = $ 176 million × (1 + 2.0%) ÷ (6.4% – 2.0%) = $ 4.1 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $ 4.1 billion ÷ (1 + 6.4%)ten= USD 2.2 billion
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 3.4 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. From the current share price of US $ 56.2, the company appears to have fair value at a 15% discount from the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
Now the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. Part of investing is making your own assessment of a company’s future performance, so try the math yourself and check your own 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 view Brady 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 takes into account debt. In this calculation, we used 6.4%, which is based on a leveraged beta of 0.924. Beta is a measure of the volatility of a stock, relative 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.
Valuation is only one side of the coin in terms of building your investment thesis, and ideally it won’t be the only analysis you look at for a business. It is not possible to obtain an infallible valuation with a DCF model. Preferably, you would apply different cases and assumptions and see how they would impact the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Brady, there are three relevant things to consider:
- Risks: As an example, we found 1 warning sign for Brady that you need to take into account before investing here.
- Future income: How does BRC’s growth rate compare to its peers and to the market in general? Dig deeper into the analyst consensus count for years to come 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 inventory to get a feel for what you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every NYSE share. If you want to find the calculation for other actions, just search here.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
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