Is Lamb Weston Holdings, Inc. (NYSE:LW) trading at a 42% discount?
Today, we’ll walk through one way to estimate the intrinsic value of Lamb Weston Holdings, Inc. (NYSE:LW) by estimating the company’s future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model for this purpose. This may sound complicated, but it’s 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.
Check out our latest analysis for Lamb Weston Holdings
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We use what is called a 2-step model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. In the first step, we need to estimate the company’s cash flow over 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 need to discount the sum of these future cash flows to arrive at an estimate of present value:
10-Year Free Cash Flow (FCF) Forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF ($, millions) | $32.0 million | $388.0 million | $558.0 million | $637.0 million | $684.0 million | $719.3 million | $749.6 million | $775.9 million | US$799.6 million | $821.3 million |
Growth rate estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Is at 5.17% | Is at 4.2% | Is at 3.52% | Is at 3.05% | Is at 2.71% |
Present value (millions of dollars) discounted at 5.3% | $30.4 | $350 | $477 | $517 | $528 | $527 | $521 | $512 | $501 | $489 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $4.5 billion
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 5.3%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = $821 million × (1 + 1.9%) ÷ (5.3%–1.9%) = $25 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $25 billion ÷ (1 + 5.3%)^{ten}= $15 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $19 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of $77.2, the company looks quite undervalued at a 42% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
Important assumptions
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. Part of investing is coming up with 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, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Lamb Weston Holdings 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 5.3%, which is based on a leveraged beta of 0.800. 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.
Next steps:
While important, calculating DCF shouldn’t be the only metric to consider when researching 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. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is the stock price below intrinsic value? For Lamb Weston Holdings, we’ve put together three relevant things you should consider:
- Risks: We believe that you should evaluate the 3 warning signs for Lamb Weston Holdings (1 makes us a little uneasy!) that we reported before investing in the company.
- Management:Did insiders increase their shares to take advantage of market sentiment about LW’s future prospects? View our management and board analysis with insights into CEO compensation and governance factors.
- 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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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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