Estimating The Intrinsic Value Of Johnson Matthey Plc (LON:JMAT)

Simply Wall St · 10/15 05:00

Key Insights

  • Johnson Matthey's estimated fair value is UK£16.48 based on 2 Stage Free Cash Flow to Equity
  • Johnson Matthey's UK£15.14 share price indicates it is trading at similar levels as its fair value estimate
  • The UK£19.16 analyst price target for JMAT is 16% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of Johnson Matthey Plc (LON:JMAT) by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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 Johnson Matthey

Is Johnson Matthey Fairly Valued?

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 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

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF (£, Millions) UK£346.0m UK£166.6m UK£216.1m UK£198.5m UK£188.4m UK£182.7m UK£180.0m UK£179.1m UK£179.5m UK£180.9m
Growth Rate Estimate Source Analyst x4 Analyst x3 Analyst x3 Est @ -8.13% Est @ -5.11% Est @ -3.00% Est @ -1.52% Est @ -0.49% Est @ 0.24% Est @ 0.75%
Present Value (£, Millions) Discounted @ 7.9% UK£321 UK£143 UK£172 UK£147 UK£129 UK£116 UK£106 UK£97.8 UK£90.9 UK£84.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£1.4b

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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.9%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = UK£181m× (1 + 1.9%) ÷ (7.9%– 1.9%) = UK£3.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£3.1b÷ ( 1 + 7.9%)10= UK£1.5b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£2.9b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£15.1, the company appears about fair value at a 8.1% 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
LSE:JMAT Discounted Cash Flow October 15th 2024

Important Assumptions

Now 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 Johnson Matthey 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 7.9%, which is based on a levered beta of 1.222. 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 Johnson Matthey

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 Chemicals market.
Opportunity
  • Annual earnings are forecast to grow faster than the British market.
  • Current share price is below our estimate of fair value.
Threat
  • Dividends are not covered by earnings.
  • Annual revenue is expected to decline over the next 3 years.

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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Johnson Matthey, we've put together three further elements you should further examine:

  1. Risks: Every company has them, and we've spotted 3 warning signs for Johnson Matthey you should know about.
  2. Future Earnings: How does JMAT'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 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 British stock every day, so if you want to find the intrinsic value of any other stock just search here.