An Intrinsic Calculation For The Estée Lauder Companies Inc. (NYSE:EL) Suggests It's 21% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Estée Lauder Companies fair value estimate is US$184

• Current share price of US$145 suggests Estée Lauder Companies is potentially 21% undervalued

• Our fair value estimate is 14% higher than Estée Lauder Companies' analyst price target of US$161

Today we will run through one way of estimating the intrinsic value of The Estée Lauder Companies Inc. (NYSE:EL) by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Estée Lauder Companies

What's The Estimated Valuation?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$938.0m	US$1.64b	US$2.32b	US$2.84b	US$3.32b	US$3.72b	US$4.07b	US$4.36b	US$4.61b	US$4.83b
Growth Rate Estimate Source	Analyst x8	Analyst x8	Analyst x5	Est @ 22.75%	Est @ 16.61%	Est @ 12.32%	Est @ 9.31%	Est @ 7.20%	Est @ 5.73%	Est @ 4.70%
Present Value ($, Millions) Discounted @ 7.6%	US$872	US$1.4k	US$1.9k	US$2.1k	US$2.3k	US$2.4k	US$2.4k	US$2.4k	US$2.4k	US$2.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$21b

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. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.3%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.6%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$4.8b× (1 + 2.3%) ÷ (7.6%– 2.3%) = US$94b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$94b÷ ( 1 + 7.6%)¹⁰= US$45b

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$66b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$145, the company appears a touch undervalued at a 21% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Estée Lauder Companies 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 7.6%, which is based on a levered beta of 1.144. 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 Estée Lauder Companies

Strength

• Debt is well covered by earnings and cashflows.

Weakness

• Earnings declined over the past year.

• Dividend is low compared to the top 25% of dividend payers in the Personal Products market.

Opportunity

• Annual earnings are forecast to grow faster than the American market.

• Trading below our estimate of fair value by more than 20%.

Threat

• Dividends are not covered by earnings.

• Annual revenue is forecast to grow slower than the American market.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Estée Lauder Companies, we've compiled three pertinent aspects you should explore:

1. Risks: Every company has them, and we've spotted 4 warning signs for Estée Lauder Companies (of which 2 are a bit unpleasant!) you should know about.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for EL's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

3. 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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.