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Does the January share price for Xylem Inc. (NYSE:XYL) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by projecting its future cash flows and then discounting them to today’s value. This is done using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not January 2019 then I highly recommend you check out the latest calculation for Xylem by following the link below.
See our latest analysis for Xylem
The calculation
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
| 2019 | 2020 | 2021 | 2022 | 2023 | |
| Levered FCF ($, Millions) | $665.91 | $755.47 | $852.20 | $913.80 | $964.14 |
| Source | Analyst x10 | Analyst x6 | Analyst x2 | Analyst x2 | Est @ 5.51% |
| Present Value Discounted @ 11.73% | $596.00 | $605.17 | $610.99 | $586.37 | $553.72 |
Present Value of 5-year Cash Flow (PVCF)= US$3.0b
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 11.7%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$964m × (1 + 2.9%) ÷ (11.7% – 2.9%) = US$11b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$11b ÷ ( 1 + 11.7%)5 = US$6.5b
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$9.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $52.56. Compared to the current share price of $65.3, the stock is fair value, maybe slightly overvalued at the time of writing.
The assumptions
I’d like to point out 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Xylem as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 11.7%, which is based on a levered beta of 1.245. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.