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An Intrinsic Calculation For Air Products and Chemicals, Inc. (NYSE:APD) Suggests It's 30% Undervalued

Key Insights

  • The projected fair value for Air Products and Chemicals is US$386 based on 2 Stage Free Cash Flow to Equity

  • Air Products and Chemicals is estimated to be 30% undervalued based on current share price of US$268

  • Our fair value estimate is 24% higher than Air Products and Chemicals' analyst price target of US$311

Does the November share price for Air Products and Chemicals, Inc. (NYSE:APD) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present 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 want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

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See our latest analysis for Air Products and Chemicals

Step By Step Through The Calculation

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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

-US$955.2m

-US$908.9m

US$365.0m

US$3.59b

US$4.36b

US$4.94b

US$5.43b

US$5.84b

US$6.19b

US$6.49b

Growth Rate Estimate Source

Analyst x9

Analyst x9

Analyst x4

Analyst x2

Analyst x2

Est @ 13.17%

Est @ 9.88%

Est @ 7.58%

Est @ 5.97%

Est @ 4.85%

Present Value ($, Millions) Discounted @ 7.3%

-US$890

-US$790

US$296

US$2.7k

US$3.1k

US$3.2k

US$3.3k

US$3.3k

US$3.3k

US$3.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$21b

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 7.3%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$6.5b× (1 + 2.2%) ÷ (7.3%– 2.2%) = US$131b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$131b÷ ( 1 + 7.3%)10= US$65b

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$86b. 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$268, the company appears quite good value at a 30% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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. 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 Air Products and Chemicals 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 7.3%, which is based on a levered beta of 1.011. 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 Air Products and Chemicals

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is well covered by earnings and cashflows.

Weakness

  • Earnings growth over the past year is below its 5-year average.

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

Opportunity

  • Annual revenue is forecast to grow faster than the American market.

  • Trading below our estimate of fair value by more than 20%.

  • Significant insider buying over the past 3 months.

Threat

  • Paying a dividend but company has no free cash flows.

  • 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 ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. Why is the intrinsic value higher than the current share price? For Air Products and Chemicals, there are three essential factors you should further examine:

  1. Risks: For instance, we've identified 2 warning signs for Air Products and Chemicals that you should be aware of.

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

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.