How far off is The Middleby Corporation (NASDAQ:MIDD) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
Check out our latest analysis for Middleby
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-year free cash flow (FCF) forecast
|Levered FCF ($, Millions)||US$687.9m||US$627.3m||US$595.0m||US$665.0m||US$737.0m||US$772.8m||US$803.6m||US$830.9m||US$855.5m||US$878.4m|
|Growth Rate Estimate Source||Analyst x7||Analyst x4||Analyst x2||Analyst x1||Analyst x1||Est @ 4.86%||Est @ 3.99%||Est @ 3.39%||Est @ 2.97%||Est @ 2.67%|
|Present Value ($, Millions) Discounted @ 9.0%||US$631||US$528||US$459||US$471||US$478||US$460||US$439||US$416||US$393||US$370|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.6b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate 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 today’s value at a cost of equity of 9.0%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$878m× (1 + 2.0%) ÷ (9.0%– 2.0%) = US$13b
Present Value or Terminal Value (PVTV)= TV / (1 + r)10= US$13b÷ ( 1 + 9.0%)10= US$5.4b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$10.0b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$151, the company appears about fair value at a 18% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don’t have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a full picture of a company’s potential performance. Given that we are looking at Middleby 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 accounts for debt. In this calculation we’ve used 9.0%, which is based on a levered beta of 1.173. Beta is a measure of a stock’s volatility, compared 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.
SWOT Analysis for Middleby
- Debt is well covered by earnings.
- Earnings declined over the past year.
- Annual earnings are forecast to grow for the next 4 years.
- Current share price is below our estimate of fair value.
- Debt is not well covered by operating cash flow.
- Annual earnings are forecast to grow slower than the American market.
While important, the DCF calculation ideally won’t be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to “what assumptions need to be true for this stock to be under/overvalued?” For example, changes in the company’s cost of equity or the risk free rate can significantly impact the valuation. For Middleby, we’ve compiled three further items you should look at:
- Risks: Consider for instance, the ever-present specter of investment risk. We’ve identified 2 warning signs with Middleby (at least 1 which can’t be ignored) and understanding them should be part of your investment process.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for MIDD’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.