Is Huntington Ingalls Industries, Inc. (NYSE: HII) 30% undervalued?

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<p class = "Canvas Atomic Canvas Text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Did the January stock price for Huntington Ingalls Industries, Inc . (NYSE: HII) consider what it's really worth? Today we will estimate the intrinsic value of the stock by discounting the expected future cash flows to their present value. I will use the Discounted Cash Flow (DCF) model. Don't be put off by the jargon, the math behind it is actually quite simple. "Data-reactid =" 27 "> Does Huntington Ingalls Industries, Inc. (NYSE: HII) 's share price in January reflect what it' s really worth?" Today, we 'll estimate the intrinsic value of the stock by determining the expected future Discount cash flows to their current value. I will use the Discounted Cash Flow (DCF) model. Don't let the jargon, the math behind it, put you off. "It's actually quite simple.

<p class = "Canvas Atom Canvas Text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Companies can be valued in a variety of ways We would like to point out that a DCF is not perfect in every situation. If you would like to find out more about discounted cash flow, you can read the reasons for this calculation in detail in the Simply Wall St analysis model, "data-reactid =" 28 "> Companies can be valued in many ways, so we would like to point out that a DCF is not suitable for every situation be read in detail in the Simply Wall St analysis model.

<p class = "canvas-atom canvas-text Mb (1,0em) Mb (0) – sm Mt (0,8em) – sm" type = "text" content = " Check out our latest analysis for Huntington Ingalls Industries "data-reactid =" 29 "> Check out our latest analysis for Huntington Ingalls Industries

Cracking numbers

We use a so-called 2-step model, which simply means that we have two different growth periods for the company's cash flows. Generally, the first stage is a higher growth and the second stage is a lower growth phase. In the first phase, we have to estimate the cash flows for the business over the next ten years. Wherever possible, we use analyst estimates. However, if these are not available, we extrapolate the previous free cash flow (FCF) from the most recent estimate or the most recently reported value. We expect companies with shrinking free cash flow to slow down their rate of shrinkage and that companies with growing free cash flow will slow down their growth rate during this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

In general, we assume that a dollar is more valuable today than a dollar in the future. Therefore, we discount the value of these future cash flows to the estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
FCF Leverage ($ million) $ 615.4 million $ 747.8 million $ 746.0 million $ 801.0 million $ 841.9 million $ 876.4 million $ 906.0 million $ 932.3 million $ 956.0 million $ 978.1 million
Growth rate Estimated source Analyst x8 Analyst x5 Analyst x2 Analyst x2 5.1% estimate Estimate at 4.09% Est @ 3.39% Est @ 2.89% Estimate at 2.55% Est @ 2.31%
Present value ($ million) reduced by 7.2% $ 574 $ 651 $ 606 $ 608 $ 596 $ 579 $ 558 $ 536 $ 513 $ 490

<p class = "canvas-atom canvas-text Mb (1,0em) Mb (0) – sm Mt (0,8em) – sm" type = "text" content = "("Est" = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = US $ 5.7b "data-reactid =" 36 ">("Est" = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = $ 5.7 billion

The second level is also known as Terminal Value. This is the company's cash flow after the first stage. The Gordon growth formula is used to calculate the final value with a future annual growth rate that corresponds to the 10-year government bond rate of 1.7%. We discount the terminal cash flows with an equity cost rate of 7.2% to today's value.

<p class = "canvas-atom canvas-text Mb (1,0em) Mb (0) – sm Mt (0,8em) – sm" type = "text" content = "Terminal value (TV)= FCF2029 × (1 + g) ÷ (r – g) = $ 978 million × (1 + 1.7%) ÷ 7.2% – 1.7%) = $ 18 billion data-reactid = 38Terminal value (TV)= FCF2029 × (1 + g) ÷ (r – g) = $ 978 million × (1 + 1.7%) ÷ 7.2% – 1.7%) = $ 18 billion

<p class = "canvas-atom canvas-text Mb (1,0em) Mb (0) – sm Mt (0,8em) – sm" type = "text" content = "Present value of the final value (PVTV)= TV / (1 + r)10= $ 18 billion (1 + 7.2%)10= US $ 9.2b "data-reactid =" 39 ">Present value of the final value (PVTV)= TV / (1 + r)10= $ 18 billion (1 + 7.2%)10= $ 9.2 billion

The total is the sum of cash flows for the next ten years plus the discounted final value, which gives the total equity value, which in this case is $ 15 billion. To get the intrinsic value per share, we divide it by the total number of shares issued. Compared to the current share price of $ 256, the company appears to be undervalued at a discount of 30% compared to the current share price. The assumptions in each calculation have a major impact on the rating. It is therefore better to consider this as a rough estimate that is not accurate to the last cent.

NYSE: HII Intrinsic Value, January 3, 2020

The assumptions

The most important parameters for a discounted cash flow are now the discount rate and, of course, the actual cash flows. Investing also includes evaluating a company's future performance itself. So try the calculation yourself and check your own assumptions. The DCF also does not take into account the potential cyclicality of an industry or the future capital requirements of a company and therefore does not provide a complete overview of a company's potential performance. Given that we consider Huntington Ingalls Industries to be potential shareholders, the cost of equity is used as the discount rate and not the cost of capital (or weighted average cost of capital, WACC) that make up debt. We used 7.2% in this calculation, based on an indebted beta of 0.996. Beta is a measure of the volatility of a share compared to the overall market. We get our beta from the industry-standard beta of globally comparable companies with a defined limit between 0.8 and 2.0, which is an appropriate range for stable business.

Next Steps:

Valuation is just one side of the coin in creating your investment thesis and shouldn't be the only metric you consider when researching a company. The DCF model is not a perfect tool for stock valuation. Rather, it should serve as a guide to "What assumptions must be made for this stock to be under or overvalued?" If a company grows at a different growth rate or if the cost of equity or risk-free interest rates changes significantly, the output can look very different. What is the reason why the stock price differs from the intrinsic value? For Huntington Ingalls Industries, I've put together three basic factors that you should consider:

  1. Financial health: Does HII have a healthy balance? Take a look at our free balance sheet analysis with six simple reviews of key factors like debt and risk.
  2. Future result: What is the growth rate of HII compared to its competitors and the broader market? Find out more about analyst consensus numbers for the coming years by accessing our free graph of analyst growth expectations.
  3. Other high quality alternatives: Are there any other high quality stocks you could hold instead of HII? Check out our interactive list of high quality stocks to get an idea of ​​what else is missing!

<p class = "canvas-atom canvas-text MB (1.0em) MB (0) – SM MB (0.8em) – SM" type = "text" content = "PS. Simply Wall St updates its DCF calculation for each US stock every day, so if you just want to find the intrinsic value of another stock Search here, "data-reactid =" 65 "> PS. Simply Wall St updates its DCF calculation for each US stock daily, so if you want to find the intrinsic value of another stock, just search here.

<p class = "canvas-atom canvas-text Mb (1,0em) Mb (0) – sm Mt (0,8em) – sm" type = "text" content = "If you discover an error that justifies a correction, please contact the editorial team at editorial-team@simplywallst.com, This article from Simply Wall St is general in nature. It is not a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Simply Wall St has no position in the stocks mentioned.

We strive to provide you with long-term, focused research analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or quality material. Thank you for reading."data-reactid =" 66 ">If you discover an error that justifies a correction, please contact the editorial team at editorial-team@simplywallst.com. This article from Simply Wall St is general in nature. It is not a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Simply Wall St has no position in the stocks mentioned.

We strive to provide you with long-term, focused research analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or quality material. Thank you for reading.