A look at the fair value of AutoZone, Inc. (NYSE:AZO)

Key findings

• The projected fair value for AutoZone is $3,331 based on the 2-step free cash flow to equity
• AutoZone’s share price of $2,833 suggests that the stock price is at a similar level to the estimated fair value
• Analysts’ price target for AZO is $3,195, 4.1% below our fair value estimate.

How far is AutoZone, Inc. (NYSE:AZO) from its intrinsic value? Using the most recent financial data, we will check whether the stock is fairly valued. To do this, we will take the company’s projected future cash flows and discount them to today’s 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 want to learn more about discounted cash flow, you can read the basics of this calculation in detail in Simply Wall St’s analysis model.

Check out our latest analysis for AutoZone

Processing the numbers

We use a two-stage DCF model which, as the name suggests, considers two phases of growth. The first stage is generally a higher growth phase that stabilizes toward the terminal value captured in the second “steady growth” stage. 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 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 all about the idea that a dollar in the future is worth less 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

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 22 billion 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 2.4%. We discount the terminal cash flows to today’s value at a cost of equity of 7.7%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = $3.8 billion × (1 + 2.4%) ÷ (7.7% – 2.4%) = $73 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 73 billion US dollars ÷ (1 + 7.7%)¹⁰= 35 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 equity value, which in this case is $57 billion. In the final step, we divide the equity value by the number of shares outstanding. Relative to the current share price of $2.8K, the company appears roughly fairly valued at a 15% 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 penny.

Important assumptions

The key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these inputs, I recommend repeating the calculations yourself and playing around with them. The DCF also doesn’t take into account the potential cyclicality of an industry or a company’s future capital needs and therefore doesn’t provide a complete picture of a company’s potential performance. Since we’re looking at AutoZone 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 takes debt into account. In this calculation, we used 7.7%, which is based on a leveraged beta of 1.151. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT Analysis for AutoZone

Next Steps:

While the DCF calculation is important, it is only one of many factors you need to evaluate 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 must be true for this stock to be under/overvalued.” For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. For AutoZone, we have compiled three important elements for you to consider:

1. Risks: For example, we found 3 Warning Signs for AutoZone (2 cannot be ignored) You should be aware of this.
2. Future income: How does AZO’s growth rate compare to its 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 high-quality alternatives: Like a good all-rounder? Explore our interactive list of high-quality stocks to get a sense of what else you might be missing out on!

PS The Simply Wall St app does a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, just search here.

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This Simply Wall St article is of a general nature. We comment 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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