Is the company Fastenal (NASDAQ: FAST) worth $51.7 based on its intrinsic value?
Today we’ll walk through one way to estimate the intrinsic value of Fastenal Company (NASDAQ:FAST) by projecting its future cash flows and then discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it’s not too hard to follow, as you’ll see in our example!
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
Check opportunities and risks within the US commercial distributor industry.
The method
We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
Estimated free cash flow (FCF) over 10 years
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF ($, millions) | $934.8 million | $984.7 million | $1.07 billion | $1.19 billion | $1.26 billion | $1.32 billion | $1.37 billion | $1.42 billion | $1.46 billion | $1.50 billion |
Growth rate estimate Source | Analyst x5 | Analyst x3 | Analyst x2 | Analyst x2 | Is at 6.18% | Is at 4.92% | Is at 4.04% | Is at 3.42% | Is 2.99% | Is at 2.69% |
Present value (in millions of dollars) discounted at 7.3% | $871 | $855 | $861 | $892 | $883 | $863 | $836 | $806 | $773 | $739 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $8.4 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 stage. 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 2.0%. We discount terminal cash flows to present value at a cost of equity of 7.3%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = $1.5 billion × (1 + 2.0%) ÷ (7.3%–2.0%) = $29 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $29 billion ÷ (1 + 7.3%)^{ten}= $14 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $22 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 US$51.7, the company looks reasonably expensive at the time of writing. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. If you disagree with these results, try the math yourself and play around with the 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 view Fastenal 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 factors in debt. In this calculation, we used 7.3%, which is based on a leveraged beta of 1.046. 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.
SWOT analysis for Fastenal
- Earnings growth over the past year has exceeded its 5-year average.
- Debt is not considered a risk.
- Earnings growth over the past year has lagged that of the commercial distributor industry.
- The dividend is low compared to the top 25% dividend payers in the commercial distributor market.
- Expensive based on P/E ratio and estimated fair value.
- Annual revenues are expected to increase over the next 3 years.
- Significant insider buying in the last 3 months.
- Dividends are not covered by cash flow.
- Annual earnings are expected to grow more slowly than the US market.
Look forward:
While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. It is not possible to obtain an infallible valuation with a DCF model. 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. If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. Why is intrinsic value lower than the current stock price? For Fastenal, we’ve put together three relevant factors you should explore:
- Risks: Take for example the ubiquitous specter of investment risk. We have identified 1 warning sign with Fastenal and understanding it should be part of your investment process.
- Future earnings: How does FAST’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years 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 strong trading fundamentals to see if there are any other companies you may not have considered!
PS. The Simply Wall St app performs a daily updated cash flow assessment for each NASDAQGS stock. If you want to find the calculation for other stocks, 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.