Important Findings
- The estimated fair value of Beacon Roofing Supply is $88.00 based on 2-step free cash flow to equity
- With a stock price of $82.98, Beacon Roofing Supply appears to be trading near its estimated fair value
- Our fair value estimate is 12% above Beacon Roofing Supply’s analyst price target of $78.33
How far is Beacon Roofing Supply, Inc. (NASDAQ:BECN) from its intrinsic value? Using the most recent financial data, we check whether the stock is fairly valued by estimating the company’s future cash flows and discounting them to present value. The Discounted Cash Flow (DCF) model is the tool we will use for this. There really isn’t much behind it, even if it seems quite complex.
We generally believe that the value of a company is the present value of all future cash generated. However, a DCF is just one evaluation metric among many and not without its shortcomings. If you want to learn more about intrinsic value, read Simply Wall St’s analysis model.
Check out our latest analysis for Beacon Roofing Supply
Crack the numbers
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first phase is generally a higher growth phase that levels off towards the terminal value captured in the second ‘steady growth’ phase. First, we need to estimate the cash flows for the next ten years. Where possible we use analyst estimates, however when these are not available we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We expect that companies with shrinking free cash flow will see their contraction rate slow and companies with growing free cash flow will see their growth rate slow over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.
A DCF involves the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
Free cash flow (FCF) estimate for 10 years
| 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
| Leveraged FCF ($, million) | $471.4 million | $494.0 million | $481.0 million | $475.1 million | $474.1 million | $476.4 million | $481.0 million | $487.3 million | $494.9 million | $503.4 million |
| Source to estimate growth rate | Analyst x6 | Analyst x1 | Is at -2.64% | Is at -1.21% | Is at -0.22% | Is at 0.48% | Is at 0.97% | Is at 1.31% | Is at 1.55% | Is at 1.72% |
| Present value (in millions of US dollars), discounted at 9.8% | $429 | $410 | $363 | $327 | $297 | $272 | $250 | $231 | $213 | $198 |
(“Est” = FCF growth rate estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = $3.0 billion
The second stage is also known as the end value. This is the company’s cash flow after the first stage. The Gordon growth formula is used to calculate terminal value given a future annual growth rate equal to the 5-year average 10-year government bond yield of 2.1%. We discount the ending cash flows to today’s value using a cost of equity rate of 9.8%.
final value (TV)= FCF2033 × (1 + g) ÷ (r – g) = $503 million × (1 + 2.1%) ÷ (9.8% – 2.1%) = $6.7 billion dollar
Present value of terminal value (PVTV)= TV / (1 + r)10 = $6.7 billion ÷ ( 1 + 9.8%)10 = $2.6 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $5.6 billion. In the final step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $83.0, the company appears about fair value at a discount of 5.7% to the current share price. However, estimates are imprecise instruments, much like a telescope: move a few degrees and end up in another galaxy. Remember.
NasdaqGS:BECN Discounted Cash Flow July 3, 2023
The Assumptions
The above calculation depends heavily on two assumptions. The first is the discount rate and the other is the cash flows. You do not have to agree with these inputs, I recommend repeating and playing with the calculations yourself. The DCF also does not take into account the potential cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Because we view Beacon Roofing Supply as a potential shareholder, the discount rate used is the cost of equity rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for the debt. In this calculation we used 9.8% which is based on a leveraged beta of 1.296. Beta is a measure of a stock’s volatility relative to the overall market. We derive our beta from the industry average of global peers with a set cutoff between 0.8 and 2.0, which is a reasonable range for a stable company.
SWOT Analysis for Beacon Roofing Supply
Strength
- Earnings growth last year exceeded that of the industry.
- Debt is well covered by income and cash flow.
weakness
- Earnings growth over the past year is below the 5-year average.
Opportunity
- Annual profit is forecast to increase over the next three years.
- Good value based on P/E and estimated fair value.
Danger
- Annual profit is expected to grow more slowly than the US market.
It continues:
While the DCF calculation is important, it shouldn’t be the only metric you consider when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you would apply different cases and assumptions and see how they would affect the company valuation. If a company grows differently, or if its cost of equity or risk-free rate changes significantly, the outcome can be very different. For Beacon Roofing Supply, there are three relevant elements that you should explore further:
- risks: Every company has them and we discovered them 2 warning labels for Beacon Roofing Supply you should know that.
- future earnings: What is the growth rate of BECN compared to its competitors and the broader market? Learn more about analyst consensus numbers for the years to come by interacting with our free Analyst Growth Expectations chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of quality stocks to get an idea of what else you might be missing out on!
hp The Simply Wall St app performs a daily discounted cash flow valuation for every stock on the NASDAQGS. If you want to find the calculation for other stocks, just search here.
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This Simply Wall St article is of a general nature. We provide commentary based on historical data and analyst forecasts solely using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to provide you with long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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