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Eric Cota
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I'm a value investor for the long term primarily focused on firms in the S&P 500 that produce solid free cash flow and pay dividends. I look for undervalued firms using a discounted cash flow model. I reinvest dividends and track performance on a total return, risk-adjusted basis. Five years... More
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  • Home Depot Inc: cash flow valuation 2 comments
    Jan 18, 2012 3:43 PM | about stocks: HD
    Current Price: ~ $45/share
    Projected Yield: ~ 2.65%




    Home Depot is the world's largest home-improvement specialty retailer, operating 2,246 warehouse-format stores throughout the United States, Canada, Mexico, and China. The company's stores offer products and services for home construction, renovation, remodeling, and maintenance. The firm is based in Atlanta and employs more than 300,000 people.        


    I estimated the firm's WACC today at 8.89% using the Capital Asset Pricing Model and the company's recent SEC filings.

    Recent free cash flows and noted growth rates:
    Year
    FCF $Millions
    2002
    2570
    2003
    2053
    2004
    2439
    2005
    2956
    2006
    2603
    2007
    4119
    2008
    2169
    2009
    3681
    2010
    4159
    2011
    3489
    TTM
    5063

    Average Annual Growth FCF: ~ 9%
    CAGR FCF: ~ 3%
    Consensus Forecast Industry 5-Year Growth: ~ 14% per year
    Consensus Forecast Company 5-Year Growth: ~ 14% per year
    Internal Growth Rate: ~ 5%
    Sustainable Growth Rate: ~ 10%

    Scenario 1
    Average FCF (TTM, 2011) is $4276 million.  Starting at $4276 million FCF, assuming the company achieves a 5-year growth rate in FCF of 14% per year, and assuming that after the next five years, the company achieves no growth or 0% growth in FCF per year forever:

    Discounted Cash Flow Valuation
    Year
    FCF $Millions
    0
    4276
    1
    4875
    2
    5557
    3
    6335
    4
    7222
    5
    8233
    Terminal Value
    105590

    The firm's future cash flows, discounted at a WACC of 8.89%, give a present value for the entire firm (Debt + Equity) of $93563 million. If the firm's fair value of debt is estimated at $12000 million, then the fair value of the firm's equity could be $81563 million.  $81563 million / 1540 million outstanding shares is approximately $53 per share and a 20% margin of safety is $42/share.


    Scenario 2
    All else being equal, assume the company achieves a 5-year growth rate in FCF of 7% per year, then growth in FCF of 2% per year forever: :

    Discounted Cash Flow Valuation
    Year
    FCF $Millions
    0
    4276
    1
    4575
    2
    4896
    3
    5238
    4
    5605
    5
    5997
    Terminal Value
    93153

    The firm's future cash flows, discounted at a WACC of 8.89%, give a present value for the entire firm (Debt + Equity) of $81145 million. If the firm's fair value of debt is estimated at $12000 million, then the fair value of the firm's equity could be $69145 million.  $69145 million / 1540 million outstanding shares is approximately $45 per share and a 20% margin of safety is $36/share.


    Sources
    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Stocks: HD
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Comments (2)
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  • Charlie Stanton
    , contributor
    Comments (9) | Send Message
     
    Question: I noticed on a recent MCD valuation you did as well as this HD valuation (scenario 1) you have a 0% growth in the Terminal Value. Why is that? Clearly there will be growth into perpetuity. Also, what is your Free Cash Flow calculation? Are you doing FCF to equity or invested capital?
    21 Jan 2012, 12:32 AM Reply Like
  • Eric Cota
    , contributor
    Comments (22) | Send Message
     
    Author’s reply » Hello BizValstanton:

     

    Thanks for the comment. Growth into perpetuity seems a bit tricky to me. I know some models choose a perpetual growth rate for the firm that's in line with long-term average growth in U.S. GDP or at least some figure that's greater than 0%. I use 0% perpetual growth as a measure of safety. I'm looking for undervalued firms that generate good FCF and pay dividends. I try to use reasonably harsh assumptions in my model to limit my chance of overpaying. Does my model more likely understate or overstate the value of the firm? -- Hopefully it understates. I accept that my harsh assumptions will cause me to pass on some good investments.

     

    As for FCF, I use
    FCF = Operating Cash Flow - Capital Expenditures and I get my data primarily from company filings and Morningstar.

     

    Again, thanks for the comment and all the best,
    Eric
    21 Jan 2012, 01:45 PM Reply Like
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