Key Insights
- The projected fair value for Titan Machinery is US$21.72 based on 2 Stage Free Cash Flow to Equity
- With US$17.60 share price, Titan Machinery appears to be trading close to its estimated fair value
- Our fair value estimate is 14% lower than Titan Machinery's analyst price target of US$25.20
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Titan Machinery Inc. (NASDAQ:TITN) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
The Calculation
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF ($, Millions) | -US$30.5m | US$73.7m | US$98.3m | US$102.5m | US$53.0m | US$50.7m | US$49.6m | US$49.1m | US$49.2m | US$49.6m |
Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Est @ -4.26% | Est @ -2.27% | Est @ -0.87% | Est @ 0.10% | Est @ 0.79% |
Present Value ($, Millions) Discounted @ 12% | -US$27.3 | US$59.2 | US$70.7 | US$66.1 | US$30.6 | US$26.3 | US$23.0 | US$20.4 | US$18.3 | US$16.6 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$304m
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 (2.4%) 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 12%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$50m× (1 + 2.4%) ÷ (12%– 2.4%) = US$551m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$551m÷ ( 1 + 12%)10= US$184m
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$488m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$17.6, the company appears about fair value at a 19% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
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Important Assumptions
We would point out that 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 Titan Machinery 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 12%, which is based on a levered beta of 2.000. 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 Titan Machinery
- Debt is well covered by earnings.
- Balance sheet summary for TITN.
- Earnings declined over the past year.
- Good value based on P/E ratio and estimated fair value.
- Significant insider buying over the past 3 months.
- Debt is not well covered by operating cash flow.
- Annual earnings are forecast to decline for the next 3 years.
- Is TITN well equipped to handle threats?
Moving On:
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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Titan Machinery, there are three fundamental elements you should further examine:
- Risks: We feel that you should assess the 2 warning signs for Titan Machinery we've flagged before making an investment in the company.
- Future Earnings: How does TITN'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.
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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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com