Is Estée Lauder Companies Inc. (NYSE: EL) expensive for a reason? A look at its intrinsic value
In this article, we’ll estimate the intrinsic value of The Estée Lauder Companies Inc. (NYSE: EL) by projecting its future cash flows and then discounting them to present value. This will be done using the Discounted Cash Flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they are easy enough to follow.
We generally believe that the value of a business is the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. For those who are learning equity analysis in depth, the Simply Wall St analysis template here may be of interest to you.
See our latest analysis for Estée Lauder Companies
The model
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 the fact 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, and so the sum of these future cash flows is then discounted to present value:
10-year Free Cash Flow (FCF) forecast
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF ($, million) | 2.50 billion USD | 2.64 billion USD | 3.02 billion USD | 3.60 billion USD | $ 3.99 billion | 4.27 billion USD | 4.51 billion USD | 4.72 billion USD | 4.89 billion USD | 5.05 billion USD |
Source of estimated growth rate | Analyst x9 | Analyst x10 | Analyst x8 | Analyst x3 | Analyst x3 | Is 7.13% | Is 5.59% | Is 4.51% | Is 3.75% | Is 3.22% |
Present value ($, million) discounted at 6.7% | US $ 2.3k | US $ 2.3k | US $ 2.5K | US $ 2.8K | US $ 2.9K | US $ 2.9K | US $ 2.9K | US $ 2.8K | US $ 2.7K | US $ 2.6K |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 27 billion USD
Now we need to calculate the terminal value, which takes into account all future cash flows after that 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 present value, using a cost of equity of 6.7%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = $ 5.1 billion × (1 + 2.0%) ÷ (6.7% – 2.0%) = $ 109 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= 109 billion USD ÷ (1 + 6.7%)^{ten}= 57 billion USD
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 $ 84 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current price of US $ 297, the company appears to be slightly overvalued 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.
Important assumptions
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. If you don’t agree with these results, try the calculation yourself and play 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 view Estée Lauder Companies 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 6.7%, which is based on a leveraged beta of 1.001. 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.
Looking forward:
While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. The DCF model is not a perfect inventory valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. What is the reason why the stock price exceeds intrinsic value? For Estée Lauder Companies, there are three essential aspects to consider:
- Risks: For example, we have identified 3 warning signs for Estée Lauder companies that you need to be aware of.
- Future income: How does EL’s growth rate compare to its peers and 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 strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
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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