Is The Middleby Corporation (NASDAQ:MIDD) trading at a 35% discount?
How far is The Middleby Corporation (NASDAQ:MIDD) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the company’s 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. There really isn’t much to do, although it may seem quite complex.
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
Step by step through the calculation
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”. To begin with, we need to obtain cash flow estimates 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, 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)||$644.2 million||$636.0 million||$634.5 million||$637.1 million||$642.6 million||$650.3 million||$659.5 million||$669.9 million||$681.2 million||$693.2 million|
|Growth rate estimate Source||Analyst x5||Analyst x2||Is @ -0.24%||Is at 0.41%||Is at 0.87%||Is at 1.19%||Is at 1.42%||Is at 1.57%||Is at 1.68%||Is at 1.76%|
|Present value (millions of dollars) discounted at 6.8%||$603||$557||$521||$489||$462||$438||$416||$395||$376||$358|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $4.6 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. 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 (1.9%) 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 6.8%.
Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = $693 million × (1 + 1.9%) ÷ (6.8%–1.9%) = $14 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $14 billion ÷ (1 + 6.8%)ten= $7.5 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $12 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$146, the company looks quite undervalued at a 35% discount to the current share price. 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.
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 entries, I recommend that you redo the calculations yourself and play around with them. 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 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 factors in debt. In this calculation, we used 6.8%, which is based on a leveraged beta of 1.150. 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.
While a business valuation is important, it shouldn’t be the only metric to consider when researching a business. It is not possible to obtain an infallible valuation with a DCF model. 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. Can we understand why the company is trading at a discount to its intrinsic value? For Middleby, we’ve compiled three additional aspects you should explore:
- Risks: For example, we discovered 2 warning signs for Middleby (1 doesn’t suit us too much!) which you should be aware of before investing here.
- Future earnings: How does MIDD’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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