A Look At The Fair Value Of ESAB Corporation (NYSE:ESAB)

ESAB Corp Ordinary Shares +0.04% Pre

ESAB Corp Ordinary Shares

ESAB

107.59

107.59

+0.04%

0.00% Pre

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, ESAB fair value estimate is US$95.10
  • Current share price of US$87.49 suggests ESAB is potentially trading close to its fair value
  • Analyst price target for ESAB is US$86.20 which is 9.4% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of ESAB Corporation (NYSE:ESAB) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for ESAB

Crunching The Numbers

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.

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$288.6m US$331.4m US$319.9m US$339.3m US$351.9m US$363.5m US$374.3m US$384.5m US$394.5m US$404.2m
Growth Rate Estimate Source Analyst x6 Analyst x5 Analyst x2 Analyst x2 Est @ 3.74% Est @ 3.28% Est @ 2.96% Est @ 2.74% Est @ 2.58% Est @ 2.48%
Present Value ($, Millions) Discounted @ 7.9% US$267 US$285 US$255 US$250 US$240 US$230 US$220 US$209 US$199 US$189

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.3b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$404m× (1 + 2.2%) ÷ (7.9%– 2.2%) = US$7.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$7.3b÷ ( 1 + 7.9%)10= US$3.4b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$5.7b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$87.5, the company appears about fair value at a 8.0% 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.

dcf
NYSE:ESAB Discounted Cash Flow December 29th 2023

The 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 ESAB 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 7.9%, which is based on a levered beta of 1.139. 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 ESAB

Strength
  • Debt is well covered by earnings and cashflows.
Weakness
  • Earnings growth over the past year underperformed the Machinery industry.
  • Dividend is low compared to the top 25% of dividend payers in the Machinery 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.

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For ESAB, we've compiled three pertinent items you should further research:

  1. Risks: You should be aware of the 2 warning signs for ESAB we've uncovered before considering an investment in the company.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ESAB's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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. 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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