The intrinsic value of CF Industries Holdings, Inc. (NYSE: CF) is potentially 97% higher than its share price
In this article, we’ll estimate the intrinsic value of CF Industries Holdings, Inc. (NYSE: CF) by taking expected future cash flows and discounting them to their present value. Our analysis will use the Discounted Cash Flow (DCF) model. Don’t be put off by the lingo, the math is actually pretty straightforward.
Businesses can be valued in many ways, so we would like to stress that a DCF is not perfect for all situations. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
Check out our latest analysis for CF Industries Holdings
The calculation
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. 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 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 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, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) estimate
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF ($, million) | $ 1.20 billion | $ 1.07 billion | $ 1.01 billion | $ 1.03 billion | $ 1.27 billion | $ 1.33 billion | $ 1.38 billion | $ 1.43 billion | $ 1.47 billion | 1.50 billion USD |
Source of estimated growth rate | Analyst x9 | Analyst x8 | Analyst x5 | Analyst x2 | Analyst x1 | Is 4.54% | Is 3.77% | Is at 3.24% | Is 2.86% | Is 2.6% |
Present value ($, millions) discounted at 7.4% | US $ 1.1K | US $ 930 | US $ 816 | US $ 774 | US $ 890 | US $ 866 | US $ 837 | US $ 804 | US $ 770 | US $ 736 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 8.5 billion USD
The second stage is also known as terminal value, it is the cash flow of the business after the first stage. 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 7.4%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = $ 1.5 billion × (1 + 2.0%) ÷ (7.4% – 2.0%) = $ 28 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= 28 billion USD ÷ (1 + 7.4%)^{ten}= 14 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 $ 22 billion. In the last step, we divide the equity value by the number of shares outstanding. From the current share price of US $ 53.0, the company appears to be quite undervalued with a 49% discount from the current share price. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.
Important assumptions
Now the most important data for a discounted cash flow is the discount rate and, of course, the actual 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 CF Industries 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 into account debt. In this calculation, we used 7.4%, which is based on a leveraged beta of 1.150. 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.
To move on:
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. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. Why is intrinsic value greater than the current share price? For CF Industries Holdings, there are three fundamental things you need to consider:
- Risks: As an example, we found 2 warning signs for CF Industries Holdings that you need to take into account before investing here.
- Management: Have insiders increased their stocks to take advantage of market sentiment for CF’s future outlook? Check out our management and board analysis with information on CEO compensation and governance factors.
- 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. 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.
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This Simply Wall St article is general in nature. It is not 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 does not have any position in the mentioned stocks.
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