Using the 2 Stage Free Cash Flow to Equity, Kennametal fair value estimate is US$37.61
Kennametal's US$29.35 share price signals that it might be 22% undervalued
The US$27.38 analyst price target for KMT is 27% less than our estimate of fair value
How far off is Kennametal Inc. (NYSE:KMT) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Step By Step Through The Calculation
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF ($, Millions)
US$176.5m
US$132.0m
US$171.0m
US$163.7m
US$160.0m
US$158.8m
US$159.2m
US$160.7m
US$163.1m
US$166.0m
Growth Rate Estimate Source
Analyst x2
Analyst x2
Analyst x1
Est @ -4.29%
Est @ -2.22%
Est @ -0.77%
Est @ 0.25%
Est @ 0.96%
Est @ 1.46%
Est @ 1.81%
Present Value ($, Millions) Discounted @ 7.3%
US$165
US$115
US$139
US$124
US$113
US$104
US$97.4
US$91.7
US$86.7
US$82.3
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$1.1b
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 (2.6%) 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 7.3%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.7b÷ ( 1 + 7.3%)10= US$1.8b
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$2.9b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$29.4, the company appears a touch undervalued at a 22% discount to where the stock price trades currently. 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.
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 Kennametal 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 7.3%, which is based on a levered beta of 1.129. 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 Kennametal
Strength
Debt is not viewed as a risk.
Dividends are covered by earnings and cash flows.
Dividend information for KMT.
Weakness
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Machinery 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
Annual revenue is forecast to grow slower than the American market.
What else are analysts forecasting for KMT?
Moving On:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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 higher than the current share price? For Kennametal, we've put together three additional elements you should further examine:
Financial Health: Does KMT have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does KMT'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.
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 (2.5%) 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 6.6%.
1.637億美元
美國$160.0百萬
1年自由現金流爲1.588億美元。
159.2百萬美元
1.607億美金
1.631億美元
1.66億美元
增長率估計來源
分析師 x2
分析師 x2
分析師x1
Est @ -4.29%
估值 @ -2.22%
預計下跌0.77%
預計 0.25%
估值爲0.96%
估計@ 1.46%
預計爲1.81%
以7.3%的折現率折現的現值($,百萬)
165美元
115美元
139美元
124美元
113美元
美元104
97.4美元
91.7美元
86.7美元
82.3美元
("Est" = Simply Wall St 估計的自由現金流增長率) 10年現金流的現值(PVCF) = 11億美元