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Calculating The Fair Value Of Coty Inc. (NYSE:COTY)

Key Insights

  • Coty's estimated fair value is US$10.92 based on 2 Stage Free Cash Flow to Equity

  • Current share price of US$11.66 suggests Coty is potentially trading close to its fair value

  • The US$13.23 analyst price target for COTY is 21% more than our estimate of fair value

Does the May share price for Coty Inc. (NYSE:COTY) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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View our latest analysis for Coty

The Method

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$419.5m

US$592.8m

US$651.7m

US$695.5m

US$732.7m

US$764.7m

US$793.0m

US$818.5m

US$842.1m

US$864.5m

Growth Rate Estimate Source

Analyst x4

Analyst x5

Analyst x4

Est @ 6.73%

Est @ 5.34%

Est @ 4.37%

Est @ 3.69%

Est @ 3.22%

Est @ 2.89%

Est @ 2.65%

Present Value ($, Millions) Discounted @ 9.4%

US$384

US$496

US$498

US$486

US$468

US$447

US$424

US$400

US$376

US$353

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.3b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.1%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 9.4%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$864m× (1 + 2.1%) ÷ (9.4%– 2.1%) = US$12b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$12b÷ ( 1 + 9.4%)10= US$5.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$9.3b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$11.7, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
dcf

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Coty 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 accounts for debt. In this calculation we've used 9.4%, which is based on a levered beta of 1.221. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Coty

Strength

  • Earnings growth over the past year exceeded the industry.

Weakness

  • Interest payments on debt are not well covered.

  • Expensive based on P/E ratio and estimated fair value.

Opportunity

  • Annual earnings are forecast to grow for the next 3 years.

Threat

  • Debt is not well covered by operating cash flow.

  • Annual earnings are forecast to grow slower than the American market.

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Coty, we've compiled three further items you should look at:

  1. Risks: Be aware that Coty is showing 2 warning signs in our investment analysis , and 1 of those is concerning...

  2. Future Earnings: How does COTY's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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