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Is Yum! Brands, Inc. (NYSE:YUM) Worth US$132 Based On Its Intrinsic Value?

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Yum! Brands fair value estimate is US$98.27

  • Yum! Brands is estimated to be 35% overvalued based on current share price of US$132

  • The US$147 analyst price target for YUM is 50% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Yum! Brands, Inc. (NYSE:YUM) by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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View our latest analysis for Yum! Brands

The Model

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$1.48b

US$1.69b

US$1.85b

US$1.98b

US$2.08b

US$2.17b

US$2.25b

US$2.33b

US$2.39b

US$2.46b

Growth Rate Estimate Source

Analyst x6

Analyst x5

Analyst x2

Est @ 6.70%

Est @ 5.32%

Est @ 4.36%

Est @ 3.68%

Est @ 3.21%

Est @ 2.88%

Est @ 2.65%

Present Value ($, Millions) Discounted @ 9.2%

US$1.4k

US$1.4k

US$1.4k

US$1.4k

US$1.3k

US$1.3k

US$1.2k

US$1.2k

US$1.1k

US$1.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$13b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.1%) 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 9.2%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$2.5b× (1 + 2.1%) ÷ (9.2%– 2.1%) = US$36b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$36b÷ ( 1 + 9.2%)10= US$15b

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$28b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$132, the company appears potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
dcf

The Assumptions

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 Yum! Brands 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 9.2%, which is based on a levered beta of 1.186. 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 Yum! Brands

Strength

  • Debt is well covered by earnings.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Earnings declined over the past year.

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

  • Expensive based on P/E ratio and estimated fair value.

Opportunity

  • Annual earnings are forecast to grow for the next 3 years.

Threat

  • Debt is not well covered by operating cash flow.

  • Total liabilities exceed total assets, which raises the risk of financial distress.

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

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for 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. 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. Why is the intrinsic value lower than the current share price? For Yum! Brands, we've compiled three additional items you should assess:

  1. Risks: Take risks, for example - Yum! Brands has 3 warning signs (and 2 which are concerning) we think you should know about.

  2. Future Earnings: How does YUM'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.

  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks 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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