Estimating The Intrinsic Value Of Sensient Technologies Corporation (NYSE:SXT)

Simply Wall St · 10/15 10:43

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Sensient Technologies fair value estimate is US$75.66
  • Sensient Technologies' US$77.86 share price indicates it is trading at similar levels as its fair value estimate
  • Peers of Sensient Technologies are currently trading on average at a 3.7% discount

In this article we are going to estimate the intrinsic value of Sensient Technologies Corporation (NYSE:SXT) by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Sensient Technologies

The Model

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. 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) US$163.9m US$140.1m US$143.5m US$146.8m US$150.3m US$153.9m US$157.6m US$161.5m US$165.4m US$169.5m
Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Est @ 2.30% Est @ 2.36% Est @ 2.40% Est @ 2.43% Est @ 2.45% Est @ 2.47% Est @ 2.48%
Present Value ($, Millions) Discounted @ 6.8% US$154 US$123 US$118 US$113 US$108 US$104 US$99.6 US$95.6 US$91.7 US$88.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.1b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (2.5%) 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 6.8%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$170m× (1 + 2.5%) ÷ (6.8%– 2.5%) = US$4.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.1b÷ ( 1 + 6.8%)10= US$2.1b

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$3.2b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$77.9, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
NYSE:SXT Discounted Cash Flow October 15th 2024

The 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 Sensient Technologies 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 6.8%, which is based on a levered beta of 1.037. 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 Sensient Technologies

Strength
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Earnings declined over the past year.
  • Dividend is low compared to the top 25% of dividend payers in the Chemicals market.
  • Expensive based on P/E ratio and estimated fair value.
Opportunity
  • Annual earnings are forecast to grow faster than the American market.
Threat
  • No apparent threats visible for SXT.

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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Sensient Technologies, we've put together three fundamental aspects you should assess:

  1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Sensient Technologies .
  2. Future Earnings: How does SXT'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 American stock every day, so if you want to find the intrinsic value of any other stock just search here.