International Paper Company (NYSE:IP) shares could be 45% below their intrinsic value estimate

Today we’ll walk through one way to estimate the intrinsic value of International Paper Company (NYSE:IP) by projecting its future cash flows and then discounting them to the present value. Our analysis will use the discounted cash flow (DCF) model. Believe it or not, it’s not too hard to follow, as you’ll see in our example!

Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.

Discover our latest analysis for International Paper

Step by step in the calculation

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in 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, so we discount the value of these future cash flows to their estimated value in today’s dollars:

Estimated free cash flow (FCF) over 10 years

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF ($, millions) $1.52 billion $1.75 billion $1.52 billion $1.44 billion $1.45 billion $1.39 billion $1.36 billion $1.35 billion $1.35 billion $1.36 billion
Growth rate estimate Source Analyst x7 Analyst x9 Analyst x3 Analyst x2 Analyst x2 Is @ -3.88% East @ -2.14% Is @ -0.92% East @ -0.07% Is at 0.53%
Present value (in millions of dollars) discounted at 5.7% $1,400 $1,600 $1,300 $1,200 $1,100 $997 $923 $864 $817 $777

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = US$11 billion

After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. For a number of reasons, a very conservative growth rate is used which 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 (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 5.7%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = $1.4 billion × (1 + 1.9%) ÷ (5.7%–1.9%) = $36 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= $36 billion ÷ (1 + 5.7%)ten= $21 billion

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is $32 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of US$46.6, the company appears to be pretty good value at a 45% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

NYSE: IP Discounted Cash Flow April 13, 2022

The hypotheses

The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the 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 complete picture of a company’s potential performance. Since we view International Paper 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 factors in debt. In this calculation, we used 5.7%, which is based on a leveraged beta of 0.900. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Look forward:

While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. DCF models are not the be-all and end-all of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. Why is the stock price below intrinsic value? For International Paper, there are three important things you should look at:

  1. Risks: Every business has them, and we’ve spotted 2 warning signs for International Paper you should know.
  2. Future earnings: How does IP’s growth rate compare to its peers and the broader market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!

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

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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