Key Insights

The projected fair value for Medtronic is US$100 based on 2 Stage Free Cash Flow to Equity With US$80.38 share price, Medtronic appears to be trading close to its estimated fair value Analyst price target for MDT is US$94.75 which is 5.6% below our fair value estimate

In this article we are going to estimate the intrinsic value of Medtronic plc (NYSE:MDT) by estimating the company's future cash flows and discounting them to their present value. This will be done 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 a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Medtronic

The Calculation

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. To begin with, we have to get estimates of 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 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, 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

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF ($, Millions)  US$5.70b US$5.94b US$6.84b US$7.22b US$7.88b US$8.38b US$8.81b US$9.19b US$9.53b US$9.84b Growth Rate Estimate Source Analyst x4 Analyst x6 Analyst x5 Analyst x1 Analyst x1 Est @ 6.35% Est @ 5.13% Est @ 4.28% Est @ 3.68% Est @ 3.26% Present Value ($, Millions) Discounted @ 8.0%  US$5.3k US$5.1k US$5.4k US$5.3k US$5.4k US$5.3k US$5.1k US$5.0k US$4.8k US$4.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$51b



We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.3%) 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 8.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$9.8b× (1 + 2.3%) ÷ (8.0%– 2.3%) = US$177b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$177b÷ ( 1 + 8.0%)10= US$82b

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$133b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$80.4, the company appears about fair value at a 20% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind. dcf

The Assumptions

Now the most important 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 redoing the calculations yourself and playing with them. 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 Medtronic 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 8.0%, which is based on a levered beta of 1.039. 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 Medtronic

Strength

Earnings growth over the past year exceeded the industry.

Debt is not viewed as a risk.

Dividends are covered by earnings and cash flows.

Weakness

Dividend is low compared to the top 25% of dividend payers in the Medical Equipment market.

Opportunity

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

Good value based on P/E ratio and estimated fair value.

Threat

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

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Medtronic, we've compiled three important elements you should further examine:

Financial Health: Does MDT have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk. Future Earnings: How does MDT'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. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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

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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.