An intrinsic calculation for XPO Logistics, Inc. (NYSE: XPO) suggests it is 35% undervalued


Does the December share price for XPO Logistics, Inc. (NYSE: XPO) reflect its true value? Today we’re going to estimate the intrinsic value of the stock by taking the company’s future cash flow forecast and discounting it to today’s value. Our analysis will use the discounted cash flow (DCF) model. Don’t be put off by the lingo, the underlying calculations are actually pretty straightforward.

We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.

The calculation

We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :

10-year Free Cash Flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leverage FCF ($, Millions) US $ 565.8 million US $ 639.2 million US $ 693.1 million US $ 738.2 million US $ 776.1 million US $ 808.5 million US $ 836.9 million US $ 862.4 million US $ 885.9 million US $ 908.0 million
Source of estimated growth rate Analyst x4 Analyst x1 Est @ 8.44% Est @ 6.49% Est at 5.13% Est @ 4.18% Is at 3.52% East @ 3.05% East @ 2.72% East @ 2.49%
Present value (in millions of dollars) discounted at 7.5% US $ 526 US $ 553 US $ 558 US $ 553 $ 541 US $ 525 US $ 505 484 USD US $ 463 $ 441

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 5.2 billion

We now need to calculate the Terminal Value, which takes into account all future cash flows after this ten year period. 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 used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 7.5%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 908 million × (1 + 2.0%) ÷ (7.5% to 2.0%) = US $ 17 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 17 billion ÷ (1 + 7.5%)ten= US $ 8.2 billion

Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is US $ 13 billion. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of US $ 75.5, the company appears to be quite undervalued with a 35% discount from the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.

NYSE: XPO Discounted Cash Flow December 7, 2021

The hypotheses

We draw your attention to the fact 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 assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view XPO Logistics as a potential shareholder, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which takes debt into account. In this calculation, we used 7.5%, which is based on a leveraged beta of 1.260. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

While important, calculating DCF shouldn’t be the only metric you look at when looking for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. What is the reason why the stock price is below intrinsic value? For XPO Logistics, we have compiled three additional aspects that you should explore further:

  1. Risks: Take risks, for example – XPO Logistics has 2 warning signs we think you should be aware.
  2. Future benefits: How does XPO’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
  3. Other strong companies: 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 trading fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock just search here.

Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) Simplywallst.com.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


Comments are closed.