How far is Quaker Chemical Corporation (NYSE: KWR) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the expected future cash flows and discounting them to the present value. One way to do this is to use the discounted cash flow (DCF) model. Don’t be put off by the jargon, the underlying calculations are actually quite simple.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
Check out our latest analysis for Quaker Chemical
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. 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.
Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF ($, millions)||$154.6 million||$165.2 million||$173.3 million||$180.3 million||$186.4 million||$192.0 million||$197.1 million||$202.0 million||$206.7 million||$211.2 million|
|Growth rate estimate Source||Analyst x4||Analyst x3||Is at 4.89%||Is at 4.02%||Is @ 3.4%||Is 2.98%||Is at 2.68%||Is at 2.47%||Is at 2.32%||Is at 2.22%|
|Present value (millions of dollars) discounted at 7.4%||$144||$143||$140||$135||$130||$125||$120||$114||$109||$103|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $1.3 billion
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which 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)= FCF2032 × (1 + g) ÷ (r – g) = US$211 million × (1 + 2.0%) ÷ (7.4%–2.0%) = US$4.0 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $4.0 billion ÷ (1 + 7.4%)ten= $1.9 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $3.2 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of US$184, the company appears around fair value at the time of writing. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
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 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 Quaker Chemical 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 7.4%, which is based on a leveraged beta of 1.058. 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 Quaker Chemical
- Debt is well covered by income.
- Revenues have declined over the past year.
- The dividend is low compared to the top 25% dividend payers in the chemicals market.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are expected to grow faster than the US market.
- Debt is not well covered by operating cash flow.
- Dividends are not covered by cash flow.
- Annual revenue is expected to grow more slowly than the US market.
While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. The DCF model is not a perfect stock valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. For Quaker Chemical, we’ve rounded up three additional things you should dig into:
- Risks: Take risks, for example – Quaker Chemical has 4 warning signs (and 1 which is a little obnoxious) that we think you should know about.
- Future earnings: How does KWR’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. 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.