Key Insights
- Sensient Technologies' estimated fair value is US$93.33 based on 2 Stage Free Cash Flow to Equity
- Sensient Technologies' US$96.37 share price indicates it is trading at similar levels as its fair value estimate
- Our fair value estimate is 2.4% lower than Sensient Technologies' analyst price target of US$95.67
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Sensient Technologies Corporation (NYSE:SXT) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
The Method
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
| 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
| Levered FCF ($, Millions) | US$127.9m | US$138.9m | US$156.7m | US$170.2m | US$181.9m | US$192.3m | US$201.7m | US$210.4m | US$218.6m | US$226.5m |
| Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Analyst x2 | Est @ 8.62% | Est @ 6.92% | Est @ 5.72% | Est @ 4.89% | Est @ 4.30% | Est @ 3.89% | Est @ 3.61% |
| Present Value ($, Millions) Discounted @ 7.2% | US$119 | US$121 | US$127 | US$129 | US$129 | US$127 | US$124 | US$121 | US$117 | US$113 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.2b
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 7.2%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$227m× (1 + 2.9%) ÷ (7.2%– 2.9%) = US$5.5b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$5.5b÷ ( 1 + 7.2%)10= US$2.7b
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 US$4.0b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$96.4, 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.
The 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 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 7.2%, which is based on a levered beta of 0.982. 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 Sensient Technologies
SWOT Analysis for Sensient Technologies
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings.
- 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.
- Annual earnings are forecast to grow faster than the American market.
- Debt is not well covered by operating cash flow.
- Dividends are not covered by cash flow.
- Annual revenue is forecast to grow slower than the American market.
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess 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 compiled three further items you should look at:
- Risks: For example, we've discovered 2 warning signs for Sensient Technologies (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
- 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.
- 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.