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Calculating The Intrinsic Value Of Medtronic plc (NYSE:MDT)

Key Insights

  • The projected fair value for Medtronic is US$96.90 based on 2 Stage Free Cash Flow to Equity

  • With US$81.95 share price, Medtronic appears to be trading close to its estimated fair value

  • The US$94.07 analyst price target for MDT is 2.9% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Medtronic plc (NYSE:MDT) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 Medtronic

Is Medtronic Fairly Valued?

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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$5.67b

US$6.54b

US$6.77b

US$6.78b

US$7.88b

US$8.26b

US$8.59b

US$8.89b

US$9.18b

US$9.45b

Growth Rate Estimate Source

Analyst x3

Analyst x3

Analyst x4

Analyst x2

Analyst x1

Est @ 4.75%

Est @ 4.04%

Est @ 3.54%

Est @ 3.19%

Est @ 2.95%

Present Value ($, Millions) Discounted @ 8.1%

US$5.2k

US$5.6k

US$5.4k

US$5.0k

US$5.3k

US$5.2k

US$5.0k

US$4.8k

US$4.5k

US$4.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$50b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 8.1%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$9.4b× (1 + 2.4%) ÷ (8.1%– 2.4%) = US$168b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$168b÷ ( 1 + 8.1%)10= US$77b

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$127b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$82.0, the company appears about fair value at a 15% 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
dcf

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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Medtronic 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 8.1%, which is based on a levered beta of 1.051. 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 Medtronic

Strength

  • Debt is not viewed as a risk.

Weakness

  • Earnings declined over the past year.

  • Dividend is low compared to the top 25% of dividend payers in the Medical Equipment market.

Opportunity

  • Annual earnings are forecast to grow for the next 3 years.

  • Good value based on P/E ratio and estimated fair value.

Threat

  • Dividends are not covered by earnings.

  • 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. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Medtronic, we've put together three further factors you should consider:

  1. Risks: Take risks, for example - Medtronic has 2 warning signs we think you should be aware of.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for MDT'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.