Estimating The Intrinsic Value Of Tempur Sealy International, Inc. (NYSE:TPX)

Tempur Sealy International Inc +0.66%

Tempur Sealy International Inc

TPX

48.59

+0.66%

Key Insights

  • Tempur Sealy International's estimated fair value is US$67.56 based on 2 Stage Free Cash Flow to Equity
  • Current share price of US$56.82 suggests Tempur Sealy International is potentially trading close to its fair value
  • The US$63.32 analyst price target for TPX is 6.3% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Tempur Sealy International, Inc. (NYSE:TPX) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Tempur Sealy International

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 begin with, we have to get estimates of 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$560.5m US$596.1m US$626.5m US$695.7m US$807.6m US$871.5m US$925.8m US$972.5m US$1.01b US$1.05b
Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x4 Analyst x2 Analyst x2 Est @ 7.92% Est @ 6.23% Est @ 5.05% Est @ 4.22% Est @ 3.64%
Present Value ($, Millions) Discounted @ 9.0% US$514 US$502 US$484 US$493 US$525 US$520 US$507 US$488 US$467 US$444

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.9b

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. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 9.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$1.1b× (1 + 2.3%) ÷ (9.0%– 2.3%) = US$16b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$16b÷ ( 1 + 9.0%)10= US$6.8b

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$12b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$56.8, the company appears about fair value at a 16% 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.

dcf
NYSE:TPX Discounted Cash Flow March 30th 2024

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Tempur Sealy 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 accounts for debt. In this calculation we've used 9.0%, which is based on a levered beta of 1.456. 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 Tempur Sealy International

Strength
  • Debt is well covered by earnings and cashflows.
  • 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 Consumer Durables market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Current share price is below our estimate of fair value.
Threat
  • Annual earnings are forecast to grow slower than the American market.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Tempur Sealy International, we've compiled three pertinent aspects you should further research:

  1. Risks: We feel that you should assess the 2 warning signs for Tempur Sealy International we've flagged before making an investment in the company.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for TPX's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. 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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