FedEx Corporation (NYSE: FDX) shares could be 27% lower than their intrinsic value estimate
In this article, we’ll estimate the intrinsic value of FedEx Corporation (NYSE: FDX) by taking expected future cash flows and discounting them to their present value. Our analysis will use the discounted cash flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you would like to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
Step by step in the calculation
We are going to use a two-step 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 “steady growth”. To begin with, we need to estimate the next ten years of cash flow. 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 stated 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 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) estimate
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF ($, Millions) | 2.60 billion US dollars | 3.72 billion US dollars | US $ 3.92 billion | US $ 4.16 billion | $ 5.00 billion | 5.37 billion US dollars | 5.68 billion US dollars | US $ 5.94 billion | US $ 6.17 billion | 6.38 billion US dollars |
Source of estimated growth rate | Analyst x8 | Analyst x6 | Analyst x4 | Analyst x1 | Analyst x1 | Is 7.4% | Est @ 5.78% | East @ 4.64% | Est @ 3.84% | East @ 3.29% |
Present value (in millions of dollars) discounted at 7.3% | $ 2.4,000 | US $ 3.2k | US $ 3.2k | US $ 3.1k | 3.5,000 USD | 3.5,000 USD | 3.5,000 USD | 3.4,000 USD | 3.3,000 USD | US $ 3.2k |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 32 billion
It is now a matter of calculating the Terminal Value, which takes into account all future cash flows after this ten-year period. 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 their present value, using a cost of equity of 7.3%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = US $ 6.4B × (1 + 2.0%) ÷ (7.3% – 2.0%) = US $ 123B
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= US $ 123 billion ÷ (1 + 7.3%)^{ten}= US $ 61 billion
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is $ 93 billion. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of US $ 255, the company appears to be slightly undervalued at a 27% discount from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
NYSE: FDX Discounted Cash Flow September 18, 2021
Important assumptions
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual 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 full picture of a company’s potential performance. Since we view FedEx 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 7.3%, which is based on a leveraged beta of 1.123. 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 a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
Looking forward:
While a business valuation is important, ideally, it won’t be the only analysis you look at for a business. It is not possible to achieve a rock-solid valuation with a DCF model. 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. What is the reason why the stock price is below intrinsic value? For FedEx, we’ve put together three additional factors that you should take a closer look at:
- Risks: For example, we discovered 1 warning sign for FedEx which you should know before investing here.
- Future benefits: How does FDX’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
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. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. 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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