I guess that's the way a DCF should be done!

Why exactly do you think a 16.28% discount is going to outperform?


Jan

Actually for the year ending Jan 2006 Wal-Mart's free cash flow was approximately $1.4 billion only.  You forgot to subtract $14.5 billion of capital expenditures...

Jan: Why exactly do you think a 16.28% discount is going to outperform?

Bruno: Actually for the year ending Jan 2006 Wal-Mart's free cash flow was approximately $1.4 billion only.  You forgot to subtract $14.5 billion of capital expenditures...

Let me clarify more on how I come up with that FCF number.

Basically, I am using net income, and assuming they stop opening new stores.  If they stopped opening new stores then the net income (which includes depreciation and amoritization) should be about what they make after maintenance cap-ex (Depr & Amor) on existing stores.

One could argue that by stopping capex spending on new stores their growth rate will be lower than what I estimated and this could very well be true.  I'm estimating the growth rate using GDP growth + SSS + effects of buybacks, or 3% + 2% + 3% = 8%. 

biscosc,

I think the growth input for your DCF is very reasonable. Nevertheless, as Bruno pointed out, using FCF before growth investments AND implying store growth basically means double counting. I guess it's more accurate if you either :
- use FCF before growth- capex with only 3%  SSS as growth estimate OR
- use discounted dividends yrs 1-10 and buybacks as a substitute for your discounted FCFs yrs 1-10

 

Think about the 2007 FCF number. Of the $12.774 Bln, only a small part is going to be available to shareholders. All the growth investments create future growth of dividends/ buybacks. Therefore, the money WMT puts into store growth is not available right away.

 

Dividends per share are likely to increase faster than FCFs, since lower store growth in a couple of years might cause growth investments to come down. Moreover, I expect the share base to decrease, causing even stronger Div per share growth. In my calculation above, I use 2% annual reduction in the number of dil. shares. This trend is also likely to lift the perpetuity value per share in 10 years, discounted by a 10% factor.

 

With the adjustments included, WMT does not appeal to me.

 

Regards,

Jan

Current Stock Price	48.36
Shares Outstanding	4173
Next Year's FCF	12774
Perpetuity Growth Rate	0.03
Discount Rate	0.1
10 Year Valuation Model	Yr 1	Yr 2	Yr 3	Yr 4	Yr 5	Yr 6	Yr 7	Yr 8	Yr 9	Yr 10
Assumed Growth Rate		0.08	0.08	0.08	0.08	0.08	0.08	0.08	0.08	0.08
Div per share	0.672	0.726	0.784	0.847	0.914	0.987	1.066	1.151	1.244	1.343
Discount Factor	1.10	1.21	1.33	1.46	1.61	1.77	1.95	2.14	2.36	2.59
Discounted Div	0.611	0.600	0.590	0.580	0.568	0.558	0.547	0.538	0.527	0.519
Perpetuity Value per share = (Yr 10 FCF x (1 + Perpetuity Rate)) / (Discount Rate - Perpetuity Rate)/(dil. Shares outstanding x (1-annual share reduction)^10)
Perpetuity Value per share =	39.43
Discounted  Div. =	5.638
Per Sh. Intrinsic Value =	Discounted  Div. Yr 1-10 Values + Discounted Perpetuity Value per share
Per Share Intrinsic Value =	$45.07
% Discount to Intrinsic Value	-6.81%

;-)))

Whitney Tilson wrote this on a Motley Fool discussion board many years back:

"Let's start with a quick example: a company buys a truck for $100,000 that it expects will last for 10 years. The company will depreciate $10,000 each year over that period -- an expense on the income statement (albeit one that is not usually broken out separately). In the first year, on the cash flow statement $10,000 will be added back in the "Depreciation and amortization" line, and the full $100,000 cash cost will appear under cap ex.

On the balance sheet, as soon as the truck is purchased, cash will decline by $100,000 and "Net property, plant and equipment" will increase by the same amount, and then decline by $10,000 per year as the depreciation is moved to the income statement.

(Incidentally, the failure to account for cap ex is one of the many reasons why EBITDA -- earnings before interest, taxes, depreciation and amortization -- is such a bogus number. EBITDA ignores very real, very necessary, and often very large capital expenditures. Occasionally there is a legitimate reason for a company to use EBITDA as its primary measure of profitability, but in general, be very wary when this is the case.)

Maintenance Cap Ex vs. Growth Cap Ex
Maintenance cap ex is what a company has to spend to maintain its existing operations and market position. In a business with low or modest growth, almost all of cap ex is typically for maintenance. In this case, depreciation will generally be roughly equal to cap ex.

Growth cap ex is what a company spends beyond what is necessary. In this case, a company is taking its free cash flow and, rather than returning it to shareholders (via dividends or stock buybacks), is investing it in the hopes of generating a return above the cost of that capital.

But how can one distinguish between the two types of cap ex, since they are combined in the cash flow statement? Good question. Sometimes a company will give guidance, but you generally just have to use your judgement. If cap ex is significantly higher than depreciation, or had been steady for many years, and suddenly spiked up, it could indicate new growth cap ex. (It could also mean that the company had been spending too little on maintenance cap ex in the past.)

If it's a steady, modest-growth business, with depreciation roughly equal to cap ex, then it's probably safe to assume that all the cap ex is for maintenance. This is also generally true at the opposite end of the spectrum: it is hard to argue that a rapidly growing company with fast-changing technologies could safely cut cap ex and maintain its market position and cash flows. (Keep in mind, however, that current cash flows may not be a good way to value this type of business.) Thus, to be conservative, I generally deduct all cap ex to arrive at free cash flow unless I have a concrete reason to do otherwise.

In Lucent's case, cap ex is somewhat higher than depreciation and amortization, which shows that Lucent is investing increasing amounts in its business (assuming that the line item for depreciation and amortization is mostly depreciation). By itself, this is neither good nor bad -- it depends on how wisely the money is being invested. I'm sure some would argue that a great deal of Lucent's cap ex is for growth, but I don't think Lucent has much choice given that it is in ferociously competitive, fast-moving industries. Thus, I believe it is correct to subtract all cap ex to arrive at free cash flow, but if you want to instead use the lower figures from the depreciation and amortization line, I won't quibble. It doesn't change the results very much.

Deducting Depreciation and Amortization Rather Than Cap Ex
There are two reasons why I sometimes deduct depreciation and amortization (D&A) rather than cap ex in my calculation of free cash flow. First, if I know a company is investing heavily in growth, then the lower figure for D&A is likely to be closer to the cost of maintenance cap ex. Second, sometimes cap ex can vary widely from quarter to quarter, which can give the false impression that free cash flow is erratic. For example, I recently analyzed Blyth (BTH) and over the past 10 quarters, cap ex has ranged from $4.9 million to $24.4 million. However, D&A has risen fairly steadily from $4.6 million to $8.7 million. Thus, when calculating Blyth's free cash flow, I deduct D&A rather than cap ex from operating cash flow."