Is There An Opportunity With Regal Rexnord Corporation's (NYSE:RRX) 26% Undervaluation?

Regal Rexnord Corporation Common Stock -0.19%

Regal Rexnord Corporation Common Stock

RRX

149.53

-0.19%

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Regal Rexnord fair value estimate is US$188
  • Regal Rexnord is estimated to be 26% undervalued based on current share price of US$139
  • Our fair value estimate is 12% higher than Regal Rexnord's analyst price target of US$168

In this article we are going to estimate the intrinsic value of Regal Rexnord Corporation (NYSE:RRX) by estimating the company's future cash flows and discounting them to their present 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 would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Regal Rexnord

Is Regal Rexnord Fairly Valued?

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$713.6m US$829.9m US$912.9m US$982.9m US$1.04b US$1.09b US$1.14b US$1.18b US$1.21b US$1.25b
Growth Rate Estimate Source Analyst x5 Analyst x4 Est @ 10.00% Est @ 7.67% Est @ 6.03% Est @ 4.89% Est @ 4.09% Est @ 3.53% Est @ 3.14% Est @ 2.86%
Present Value ($, Millions) Discounted @ 10.0% US$649 US$686 US$686 US$672 US$648 US$618 US$585 US$551 US$516 US$483

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$6.1b

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 10.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$1.2b× (1 + 2.2%) ÷ (10.0%– 2.2%) = US$16b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$16b÷ ( 1 + 10.0%)10= US$6.4b

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$12b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$139, the company appears a touch undervalued at a 26% 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:RRX Discounted Cash Flow January 30th 2024

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. 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 Regal Rexnord 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 10.0%, which is based on a levered beta of 1.551. 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 Regal Rexnord

Strength
  • No major strengths identified for RRX.
Weakness
  • Interest payments on debt are not well covered.
  • Dividend is low compared to the top 25% of dividend payers in the Electrical market.
Opportunity
  • Expected to breakeven next year.
  • Has sufficient cash runway for more than 3 years based on current free cash flows.
  • Good value based on P/S ratio and estimated fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Paying a dividend but company is unprofitable.

Next Steps:

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. Why is the intrinsic value higher than the current share price? For Regal Rexnord, there are three essential aspects you should further examine:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Regal Rexnord , and understanding it should be part of your investment process.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for RRX'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.

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