Is L3Harris Technologies, Inc. (NYSE:LHX) Trading At A 45% Discount?

L3 HARRIS TECHNOLOGIES INC +0.06%

L3 HARRIS TECHNOLOGIES INC

LHX

223.25

+0.06%

Key Insights

  • L3Harris Technologies' estimated fair value is US$382 based on 2 Stage Free Cash Flow to Equity
  • L3Harris Technologies is estimated to be 45% undervalued based on current share price of US$210
  • The US$243 analyst price target for LHX is 36% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of L3Harris Technologies, Inc. (NYSE:LHX) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for L3Harris Technologies

The Model

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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) estimate

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$2.25b US$2.57b US$2.87b US$3.07b US$3.29b US$3.46b US$3.61b US$3.74b US$3.86b US$3.97b
Growth Rate Estimate Source Analyst x8 Analyst x11 Analyst x6 Analyst x2 Analyst x1 Est @ 5.13% Est @ 4.26% Est @ 3.65% Est @ 3.22% Est @ 2.92%
Present Value ($, Millions) Discounted @ 6.5% US$2.1k US$2.3k US$2.4k US$2.4k US$2.4k US$2.4k US$2.3k US$2.3k US$2.2k US$2.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$23b

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 (2.2%) 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 6.5%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$4.0b× (1 + 2.2%) ÷ (6.5%– 2.2%) = US$94b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$94b÷ ( 1 + 6.5%)10= US$50b

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$72b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$210, the company appears quite undervalued at a 45% 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.

dcf
NYSE:LHX Discounted Cash Flow January 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. 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 L3Harris Technologies 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 6.5%, which is based on a levered beta of 0.866. 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 L3Harris Technologies

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Aerospace & Defense 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
  • Debt is not well covered by operating cash flow.
  • Annual revenue is forecast to grow slower than the American market.

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. What is the reason for the share price sitting below the intrinsic value? For L3Harris Technologies, there are three further elements you should assess:

  1. Risks: As an example, we've found 2 warning signs for L3Harris Technologies (1 can't be ignored!) that you need to consider before investing here.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for LHX'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

Every question you ask will be answered
Scan the QR code to contact us
whatsapp
Also you can contact us via