Advertisement
Singapore markets close in 7 hours 45 minutes
  • Straits Times Index

    3,309.92
    -3.56 (-0.11%)
     
  • Nikkei

    39,224.80
    +437.42 (+1.13%)
     
  • Hang Seng

    19,553.61
    0.00 (0.00%)
     
  • FTSE 100

    8,420.26
    -18.39 (-0.22%)
     
  • Bitcoin USD

    66,313.70
    -654.06 (-0.98%)
     
  • CMC Crypto 200

    1,357.11
    -16.73 (-1.22%)
     
  • S&P 500

    5,303.27
    +6.17 (+0.12%)
     
  • Dow

    40,003.59
    +134.19 (+0.34%)
     
  • Nasdaq

    16,685.97
    -12.33 (-0.07%)
     
  • Gold

    2,439.00
    +21.60 (+0.89%)
     
  • Crude Oil

    79.87
    -0.19 (-0.24%)
     
  • 10-Yr Bond

    4.4200
    +0.0430 (+0.98%)
     
  • FTSE Bursa Malaysia

    1,618.28
    +1.66 (+0.10%)
     
  • Jakarta Composite Index

    7,317.24
    -7,246.70 (-49.76%)
     
  • PSE Index

    6,618.69
    -9.51 (-0.14%)
     

Are Kadant Inc. (NYSE:KAI) Investors Paying Above The Intrinsic Value?

Key Insights

  • Kadant's estimated fair value is US$224 based on 2 Stage Free Cash Flow to Equity

  • Current share price of US$300 suggests Kadant is potentially 34% overvalued

  • Our fair value estimate is 35% lower than Kadant's analyst price target of US$343

In this article we are going to estimate the intrinsic value of Kadant Inc. (NYSE:KAI) by taking the expected future cash flows and discounting them to today's 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 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

ADVERTISEMENT

Check out our latest analysis for Kadant

The Method

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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$117.7m

US$137.3m

US$137.6m

US$138.7m

US$140.4m

US$142.6m

US$145.1m

US$147.9m

US$151.0m

US$154.2m

Growth Rate Estimate Source

Analyst x2

Analyst x2

Est @ 0.17%

Est @ 0.80%

Est @ 1.25%

Est @ 1.56%

Est @ 1.78%

Est @ 1.93%

Est @ 2.04%

Est @ 2.12%

Present Value ($, Millions) Discounted @ 7.1%

US$110

US$120

US$112

US$105

US$99.6

US$94.4

US$89.7

US$85.4

US$81.4

US$77.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$975m

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$154m× (1 + 2.3%) ÷ (7.1%– 2.3%) = US$3.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.3b÷ ( 1 + 7.1%)10= US$1.6b

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$2.6b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$300, the company appears reasonably expensive at the time of writing. 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

Important Assumptions

Now 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 Kadant 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 7.1%, which is based on a levered beta of 1.047. 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 Kadant

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 Machinery market.

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

Opportunity

  • Annual earnings are forecast to grow for the next 2 years.

Threat

  • Annual earnings are forecast to grow slower than the American market.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a premium to intrinsic value? For Kadant, there are three essential items you should explore:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Kadant , and understanding it should be part of your investment process.

  2. Future Earnings: How does KAI's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  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.

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.