Are Investors Undervaluing Lowe's Companies, Inc. (NYSE:LOW) By 22%?
Lowe's Companies' estimated fair value is US$244 based on 2 Stage Free Cash Flow to Equity
Lowe's Companies is estimated to be 22% undervalued based on current share price of US$189
The US$230 analyst price target for LOW is 6.1% less than our estimate of fair value
Does the March share price for Lowe's Companies, Inc. (NYSE:LOW) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
See our latest analysis for Lowe's Companies
Is Lowe's Companies Fairly Valued?
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
Levered FCF ($, Millions)
Growth Rate Estimate Source
Est @ 3.79%
Est @ 3.27%
Est @ 2.91%
Est @ 2.66%
Present Value ($, Millions) Discounted @ 8.8%
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$66b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.1%) 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 8.8%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$12b× (1 + 2.1%) ÷ (8.8%– 2.1%) = US$189b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$189b÷ ( 1 + 8.8%)10= US$81b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$147b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$189, the company appears a touch undervalued at a 22% 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.
Now 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 these result, have a go at the calculation yourself and play with the 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 Lowe's 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 8.8%, which is based on a levered beta of 1.135. 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 Lowe's Companies
Debt is well covered by earnings and cashflows.
Dividends are covered by earnings and cash flows.
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Specialty Retail market.
Annual earnings are forecast to grow for the next 3 years.
Good value based on P/E ratio and estimated fair value.
Total liabilities exceed total assets, which raises the risk of financial distress.
Annual earnings are forecast to grow slower than the American market.
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For Lowe's Companies, we've put together three important elements you should further examine:
Risks: As an example, we've found 3 warning signs for Lowe's Companies (1 doesn't sit too well with us!) that you need to consider before investing here.
Future Earnings: How does LOW's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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