The intrinsic value of Terminix Global Holdings, Inc. (NYSE: TMX) is potentially 67% higher than its share price
Does the October share price for Terminix Global Holdings, Inc. (NYSE: TMX) reflect what it is really worth? Today we’re going to estimate the intrinsic value of the stock by taking the company’s future cash flow forecast and discounting it to today’s value. One way to do this is to use the Discounted Cash Flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they are fairly easy to follow.
Keep in mind, however, that there are many ways to estimate the value of a business and that a DCF is just one method. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
Crunch the numbers
We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. In the first step, 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 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.
In general, 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) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF ($, Millions) | US $ 238.0 million | US $ 261.3 million | US $ 311.0 million | US $ 335.0 million | US $ 353.0 million | US $ 368.4 million | US $ 381.8 million | US $ 393.7 million | US $ 404.7 million | US $ 414.9 million |
Source of growth rate estimate | Analyst x6 | Analyst x4 | Analyst x1 | Analyst x1 | East @ 5.38% | East @ 4.35% | East @ 3.63% | Est @ 3.13% | East @ 2.78% | Is 2.53% |
Present value (in millions of dollars) discounted at 6.0% | US $ 225 | 233 USD | US $ 261 | US $ 266 | US $ 264 | US $ 260 | US $ 254 | US $ 248 | 240 USD | 232 USD |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 2.5 billion
It is now a matter of calculating the Terminal Value, which takes into account 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 of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 6.0%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = US $ 415 million × (1 + 2.0%) ÷ (6.0% – 2.0%) = US $ 11 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= US $ 11 billion ÷ (1 + 6.0%)^{ten}= US $ 5.9 billion
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is $ 8.4 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of US $ 40.4, the company appears to be quite undervalued with a 40% discount from the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
NYSE: TMX Discounted Cash Flow October 15, 2021
The hypotheses
We would like to stress that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. 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 Terminix Global 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 6.0%, which is based on a leveraged beta of 0.915. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Looking forward:
Valuation is only one side of the coin in terms of building your investment thesis, and 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, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. Can we understand why the company trades at a discount to its intrinsic value? For Terminix Global Holdings, you need to consider three important factors:
- Risks: We think you should evaluate the 2 warning signs for Terminix Global Holdings we reported before making an investment in the business.
- Management: Have insiders increased their stocks to take advantage of market sentiment about TMX’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
- 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 any of the stocks mentioned.
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