HNI Corporation (NYSE:HNI)’s intrinsic value may be 62% above its share price

How far is HNI Corporation (NYSE:HNI) from its intrinsic value? Using the most recent financial data, we will check if the stock is fairly valued by estimating the company’s future cash flows and discounting them to their current value using the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too difficult to follow as you’ll see from our example!

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without its flaws. If you still have some burning questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for HNI

The calculation

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, we need to estimate 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 that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow more in the early years than in later years.

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

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 965 million US dollars

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.0%. We discount the terminal cash flows to today’s value at a cost of equity of 6.3%.

Final value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = 138 million US dollars × (1 + 2.0%) ÷ (6.3% – 2.0%) = 3.2 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 3.2 billion US dollars ÷ (1 + 6.3%)¹⁰= 1.7 billion US dollars

The total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is $2.7 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of $38.1, the company appears quite undervalued at a 38% discount to the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s better to consider this a rough estimate that isn’t accurate to the last cent.

Important assumptions

The above calculation heavily depends on two assumptions. The first is the discount rate and the other is the cash flows. If you disagree with these results, try the calculation yourself and play with the assumptions. DCF also does not take into account the possible cyclicality of an industry or the future capital requirements of a company and hence does not give a complete picture of the potential performance of a company. Since we consider HNIs as 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) which takes into account debt. In this calculation, we have used 6.3% which is based on a leveraged beta of 0.997. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of 0.8 to 2.0 which is a reasonable range for a stable company.

Looking ahead:

Valuation is just one side of the coin in building your investment thesis and ideally should not be the only analysis you look at for a company. It is not possible to get a foolproof valuation using a DCF model. Rather, it should be viewed as a guide to “what assumptions need to hold for this stock to be under/overvalued”. For example, slightly adjusting the terminal value growth rate can dramatically change the overall outcome. Can we find out why the company is trading at a discount to intrinsic value? For HNI, there are three relevant aspects you should look into:

1. Risks: For example, we found 1 warning sign for HNI that you should know before investing here.

2. Future income: How is HNI’s growth rate compared to competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.

3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock daily, so if you want to find out the intrinsic value of another stock, just search here.

This Simply Wall St article is of a general nature. We comment based solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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