Embedded Value Estimate of AdvanSix Inc. (NYSE: ASIX)
Does AdvanSix Inc.’s July (NYSE: ASIX) share price reflect its true value? Today we’re going to estimate the intrinsic value of the stock by taking expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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 a DCF is just one method. Anyone who wants to learn a little more about intrinsic value should read the Simply Wall St.
Is AdvanSix properly evaluated?
We use what is called a two-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. In the first step, we need to estimate the cash flow of the business over the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. 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 down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :
10-year free cash flow (FCF) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF ($, Millions) | US $ 47.6 million | US $ 47.2 million | US $ 47.2 million | US $ 47.5 million | US $ 48.0 million | US $ 48.7 million | US $ 49.4 million | US $ 50.2 million | US $ 51.1 million | US $ 52.0 million |
Source of estimated growth rate | Est @ -1.96% | East @ -0.77% | Is 0.06% | East @ 0.64% | East @ 1.04% | Est @ 1.33% | Is @ 1.53% | East @ 1.67% | East @ 1.76% | East @ 1.83% |
Present value (in millions of dollars) discounted at 7.5% | US $ 44.2 | US $ 40.8 | US $ 38.0 | US $ 35.6 | US $ 33.4 | US $ 31.5 | $ 29.8 | US $ 28.1 | US $ 26.6 | $ 25.2 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 333 million US dollars
It is now a matter of calculating the Terminal Value, which takes into account 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 of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 7.5%.
Terminal value (TV)= FCF_{2031} Ã— (1 + g) Ã· (r – g) = US $ 52 million Ã— (1 + 2.0%) Ã· (7.5% to 2.0%) = US $ 962 million
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= US $ 962m (1 + 7.5%)^{ten}= US $ 467 million
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is US $ 800 million. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of US $ 29.2, the company appears to be around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
NYSE: ASIX Discounted Cash Flow July 19, 2021
Important assumptions
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play with them. 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 AdvanSix 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 debt into account. In this calculation, we used 7.5%, which is based on a leveraged beta of 1.169. 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 from globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next steps:
While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. DCF models are not the alpha and omega of investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For AdvanSix, we have put together three relevant things that you should consider further:
- Risks: To do this, you need to know the 1 warning sign we spotted with AdvanSix.
- Future benefits: How does ASIX’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading fundamentals to see if there are other companies you might not have considered!
PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock just search here.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is 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 documents. Simply Wall St has no position in the mentioned stocks.
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