R.R. Donnelley & Sons (RRD) is a prominent player in the traditional media and printing services. Established in 1864, the Chicago-headquartered company provides pre-media, logistics and business process outsourcing products worldwide. It recently announced a multi-year, multi-million contract with Office Depot to provide a range of production and related services. The contract is expected to benefit both companies. RRD was able to increase its earnings at a double-digit rate in the last 5 years. However, the stock was a disappointment, and is trading well-below its pre-crises valuation.
As of the time of writing, R.R. Donnelley stock was trading at $13.23 with a 52-week range of $11.25 - $21.34. It has a market cap of $2.5 billion. Trailing twelve month [ttm] P/E ratio is 11.6, and forward P/E ratio is 7.4. P/B, P/S, and P/CF ratios stand at 1.4, 0.3 and 3.6, respectively. Operating margin is 4.4%, and net profit margin is 2.2%. The company has some serious debt issues. Debt/equity ratio is 1.9, but this is still lower than the industry average. R.R. Donnelley offers a nifty yield of 7.8%, fully supported by both its earnings and free cash flow.
R.R. Donnelley has a 3-star rating from Morningstar. Out of 2 analysts covering the company, 1 has a buy, and 1 has an outperform rating. Wall Street has diverse opinions on R.R. Donnelley's future. Average five-year annualized growth forecast estimate is 10%. This is a reasonable estimate, given the double-digit growth rate in the past 5 years.
What is the fair value of R.R. Donnelley given the forecast estimates? We can estimate R.R. Donnelley's fair value using discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($1.18 + $1.74) / 2 = $1.46
Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 10%. Book value per share is $9.61. The rest is as follows:
Fair Value Estimator | ||
V (t=0) | E0 | $1.46 |
V (t=1) | E0 (1+g)/(1+r) | $1.45 |
V (t=2) | E0((1+g)/(1+r))2 | $1.43 |
V (t=3) | E0((1+g)/(1+r))3 | $1.42 |
V (t=4) | E0((1+g)/(1+r))4 | $1.41 |
V (t=5) | E0((1+g)/(1+r))5 | $1.40 |
Disposal Value | E0(1+g)5/[r(1+r)5] | $12.69 |
Book Value | BV | $9.61 |
Fair Value Range | Lower Boundary | $21 |
Upper Boundary | $31 | |
Minimum Potential | 60% | |
Maximum Potential | 133% | |
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