Australia markets close in 9 minutes
  • ALL ORDS

    7,543.90
    +7.80 (+0.10%)
     
  • ASX 200

    7,242.70
    +17.50 (+0.24%)
     
  • AUD/USD

    0.7079
    -0.0015 (-0.21%)
     
  • OIL

    67.74
    +1.24 (+1.86%)
     
  • GOLD

    1,772.50
    +9.80 (+0.56%)
     
  • BTC-AUD

    80,034.25
    -482.95 (-0.60%)
     
  • CMC Crypto 200

    1,440.87
    +1.99 (+0.14%)
     
  • AUD/EUR

    0.6262
    -0.0012 (-0.19%)
     
  • AUD/NZD

    1.0412
    +0.0013 (+0.13%)
     
  • NZX 50

    12,676.50
    +6.26 (+0.05%)
     
  • NASDAQ

    15,990.76
    +113.04 (+0.71%)
     
  • FTSE

    7,129.21
    -39.47 (-0.55%)
     
  • Dow Jones

    34,639.79
    +617.75 (+1.82%)
     
  • DAX

    15,263.11
    -209.59 (-1.35%)
     
  • Hang Seng

    23,612.43
    -176.50 (-0.74%)
     
  • NIKKEI 225

    27,909.02
    +155.65 (+0.56%)
     

Estimating The Fair Value Of Xylem Inc. (NYSE:XYL)

  • Oops!
    Something went wrong.
    Please try again later.
·5-min read
In this article:
  • Oops!
    Something went wrong.
    Please try again later.

Today we will run through one way of estimating the intrinsic value of Xylem Inc. (NYSE:XYL) by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

View our latest analysis for Xylem

Is Xylem fairly valued?

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. To begin with, we have to get estimates of the next ten years of cash flows. 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

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Levered FCF ($, Millions)

US$586.2m

US$679.4m

US$790.7m

US$893.8m

US$969.5m

US$1.03b

US$1.09b

US$1.13b

US$1.17b

US$1.21b

Growth Rate Estimate Source

Analyst x8

Analyst x7

Analyst x3

Analyst x2

Est @ 8.47%

Est @ 6.52%

Est @ 5.15%

Est @ 4.19%

Est @ 3.52%

Est @ 3.05%

Present Value ($, Millions) Discounted @ 6.9%

US$548

US$595

US$648

US$685

US$695

US$693

US$681

US$664

US$643

US$620

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$6.5b

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.9%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$1.2b× (1 + 2.0%) ÷ (6.9%– 2.0%) = US$25b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$25b÷ ( 1 + 6.9%)10= US$13b

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$19b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$126, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
dcf

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Xylem 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 6.9%, which is based on a levered beta of 1.125. 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.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess 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?" 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 Xylem, we've put together three additional aspects you should look at:

  1. Risks: Case in point, we've spotted 2 warning signs for Xylem you should be aware of.

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

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.

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

Our goal is to create a safe and engaging place for users to connect over interests and passions. In order to improve our community experience, we are temporarily suspending article commenting