Key Insights
- ATI's estimated fair value is US$82.12 based on 2 Stage Free Cash Flow to Equity
- Current share price of US$84.97 suggests ATI is potentially trading close to its fair value
- Our fair value estimate is 1.5% higher than ATI's analyst price target of US$80.89
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of ATI Inc. (NYSE:ATI) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
What's The Estimated Valuation?
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
| 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
| Levered FCF ($, Millions) | US$303.3m | US$404.5m | US$461.5m | US$504.7m | US$542.2m | US$575.2m | US$604.8m | US$631.9m | US$657.3m | US$681.6m |
| Growth Rate Estimate Source | Analyst x4 | Analyst x3 | Analyst x2 | Est @ 9.36% | Est @ 7.43% | Est @ 6.09% | Est @ 5.14% | Est @ 4.48% | Est @ 4.02% | Est @ 3.70% |
| Present Value ($, Millions) Discounted @ 7.3% | US$283 | US$352 | US$374 | US$381 | US$382 | US$377 | US$370 | US$360 | US$349 | US$338 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.6b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$682m× (1 + 2.9%) ÷ (7.3%– 2.9%) = US$16b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$16b÷ ( 1 + 7.3%)10= US$8.0b
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$12b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$85.0, the company appears around fair value at the time of writing. The assumptions in any calculation 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.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 ATI 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 1.001. 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.
Check out our latest analysis for ATI
SWOT Analysis for ATI
- Debt is well covered by earnings and cashflows.
- Earnings growth over the past year underperformed the Aerospace & Defense industry.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow faster than the American market.
- Annual revenue is forecast to grow slower than the American market.
Moving On:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For ATI, we've compiled three relevant elements you should explore:
- Risks: Take risks, for example - ATI has 2 warning signs we think you should be aware of.
- Future Earnings: How does ATI'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.
- 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.
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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.