In this article, we will estimate the intrinsic value of Masonite International Corporation (NYSE: DOOR) by estimating the company’s future cash flows and discounting them to their present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it may seem quite complex.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St Analysis Template.
What is the estimated valuation?
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, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF ($, millions)||$225.4 million||$245.2 million||$259.9 million||$272.4 million||$283.1 million||$292.6 million||$301.2 million||$309.1 million||$316.6 million||$323.9 million|
|Growth rate estimate Source||Analyst x4||Analyst x3||Is at 6%||Is at 4.79%||Is at 3.94%||Is at 3.35%||Is at 2.93%||Is at 2.64%||Is at 2.44%||Is at 2.29%|
|Present value (millions of dollars) discounted at 7.9%||$209||$211||$207||$201||$193||$185||$177||$168||$160||$151|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $1.9 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. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 7.9%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$324 million × (1 + 2.0%) ÷ (7.9%–2.0%) = US$5.5 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $5.5 billion ÷ (1 + 7.9%)ten= $2.6 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $4.5 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$111, the company appears to be pretty good value at a 41% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Masonite International 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 7.9%, which is based on a leveraged beta of 1.359. 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.
Although important, the DCF calculation is just one of many factors you need to assess for 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, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is the stock price below intrinsic value? For Masonite International, we’ve compiled three fundamentals you should consider:
- Risks: For example, we spotted 2 warning signs for Masonite International you should be aware.
- Management: Did insiders increase their shares to take advantage of market sentiment regarding DOOR’s future prospects? Discover our management and board analysis with information on CEO compensation and governance factors.
- Other high-quality alternatives: Do you like a good all-rounder? To explore our interactive list of high-quality actions to get an idea of what else you might be missing!
PS. Simply Wall St updates its DCF calculation daily for every US stock, so if you want to find the intrinsic value of any other stock, search here.
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