Using the 2 Stage Free Cash Flow to Equity, International Paper fair value estimate is US$67.61
International Paper is estimated to be 50% undervalued based on current share price of US$33.83
Analyst price target for IP is US$40.09 which is 41% below our fair value estimate
Does the April share price for International Paper Company (NYSE:IP) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
The Calculation
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF ($, Millions)
US$817.3m
US$1.05b
US$1.24b
US$1.09b
US$1.13b
US$1.15b
US$1.16b
US$1.18b
US$1.21b
US$1.23b
Growth Rate Estimate Source
Analyst x3
Analyst x6
Analyst x3
Analyst x1
Analyst x1
Est @ 1.33%
Est @ 1.62%
Est @ 1.82%
Est @ 1.96%
Est @ 2.06%
Present Value ($, Millions) Discounted @ 6.6%
US$767
US$921
US$1.0k
US$845
US$822
US$781
US$745
US$712
US$681
US$652
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$7.9b
The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.3%) 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 6.6%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$29b÷ ( 1 + 6.6%)10= US$16b
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$23b. 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$33.8, the company appears quite undervalued at a 50% 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.
NYSE:IP Discounted Cash Flow April 28th 2024
Important Assumptions
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 International Paper 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 6.6%, which is based on a levered beta of 0.933. 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 International Paper
Strength
Debt is well covered by earnings and cashflows.
Dividend is in the top 25% of dividend payers in the market.
Dividend information for IP.
Weakness
Earnings declined over the past year.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Trading below our estimate of fair value by more than 20%.
Threat
Dividends are not covered by earnings.
Annual revenue is forecast to grow slower than the American market.
See IP's dividend history.
Looking Ahead:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For International Paper, we've compiled three essential elements you should explore:
Risks: For instance, we've identified 4 warning signs for International Paper that you should be aware of.
Future Earnings: How does IP'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. 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.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com. 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.
