A Look At The Fair Value Of Constellation Brands, Inc. (NYSE:STZ)

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="How far off is Constellation Brands, Inc. (NYSE:STZ) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. I will be using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!” data-reactid=”18″>How far off is Constellation Brands, Inc. (NYSE:STZ) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. I will be using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.” data-reactid=”19″>Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. 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.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content=" See our latest analysis for Constellation Brands ” data-reactid=”20″> See our latest analysis for Constellation Brands

Step by step through the calculation

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. 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 are 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) forecast

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Present Value of 10-year Cash Flow (PVCF)= $13.40b” data-reactid=”27″>Present Value of 10-year Cash Flow (PVCF)= $13.40b

“Est” = FCF growth rate estimated by Simply Wall St

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 10-year government bond rate of 2.7%. We discount the terminal cash flows to today’s value at a cost of equity of 7.8%.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Terminal Value (TV) = FCF₂₀₂₉ × (1 + g) ÷ (r – g) = US$2.7b × (1 + 2.7%) ÷ (7.8% – 2.7%) = US$55b” data-reactid=”30″>Terminal Value (TV) = FCF₂₀₂₉ × (1 + g) ÷ (r – g) = US$2.7b × (1 + 2.7%) ÷ (7.8% – 2.7%) = US$55b

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Present Value of Terminal Value (PVTV) = TV / (1 + r)¹⁰ = $US$55b ÷ ( 1 + 7.8%)¹⁰ = $26.00b” data-reactid=”31″>Present Value of Terminal Value (PVTV) = TV / (1 + r)¹⁰ = $US$55b ÷ ( 1 + 7.8%)¹⁰ = $26.00b

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="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 $39.40b. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of $207.52. Relative to the current share price of $198.8, the company appears about fair value at a 4.2% discount to what it is available for right now. The assumptions in a DCF 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.” data-reactid=”32″>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 $39.40b. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of $207.52. Relative to the current share price of $198.8, the company appears about fair value at a 4.2% discount to what it is available for right now. The assumptions in a DCF 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.

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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. 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 Constellation Brands 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 7.8%, which is based on a levered beta of 0.853. 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.