In this article, let´s take a look at Weyerhaeuser Co. (WY, Financial), which has raised, in past days, its quarterly dividend to $0.31 from $0.29 a share. This way, the stock yields 4.4% if the share price stays at current levels. The hike reflects Weyerhaeuser´s policy of returning value to shareholders and help to continue with a good dividend growth, the company more than doubled the dividend rate since 2011.
New position
Value-oriented investor Jean-Marie Eveillard is the major shareholder of the company, with a stake containing 14.75 million shares, valued at $464.76 million at the end of the second quarter. Moreover, Louis Moore Bacon (Trades, Portfolio) has initiated a new position in the stock with 75,000 shares.
More value to shareholders
Also, the board has authorized a new share repurchase program of up to $500 million. This buyback program commences upon completion of the existing $700 million share repurchase program authorized last year. As of June 30, with the prior program the company had repurchased $610 million of the $700 million authorization.
Intrinsic value
The Yahoo! (YHOO, Financial) Finance consensus price target is $36.45, so now let´s try to estimate the fair value of the firm; for that purpose I will use the Dividend Discount Model (DDM). In stock valuation models, DDM define cash flow as the dividends to be received by the shareholders. The model requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model).
Once we select the appropriate model, we can forecast dividends up to the end of the investment horizon where we no longer have confidence in the forecasts and then forecast a terminal value based on some other method, such as a multiple of book value or earnings.
Let´s estimate the inputs for modeling:
First, we need to calculate the different discount rates, i.e. the cost of equity (from CAPM). The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stock j = risk-free rate + beta of j x equity risk premium
Risk-Free Rate: Rate of return on LT Government Debt: RF = 3.03%[1]. I think this is a very low rate. Since 1900, yields have ranged from a little less than 2% to 15%; with an average rate of 4.9%. It is more appropriate to use this rate.
Gordon Growth Model Equity Risk Premium = (1-year forecasted dividend yield on market index) + (consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[2]
Beta: From Yahoo! Finance we obtain a β = 1.00268
The result given by the CAPM is a cost of equity of: rWY = RF + βWY [GGM ERP] = 4.9% + 1.01 [11.43%] = 16.36%
Dividend growth rate (g)
The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm´s debt-to-equity ratio is unchanged, and it doesn´t issue new equity.
g = b x ROE
b = retention rate
ROE = (Net Income)/Equity= ((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)
The “PRAT” Model:
g= ((Net Income-Dividends)/(Net Income)).((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)
Collecting the financial information for the last three years, each ratio was calculated, and then to have a better approximation I proceeded to find the three-year average:
| Retention rate | 0.32 |
| Profit margin | 0.13 |
| Asset turnover | 0.51 |
| Financial leverage | 2.64 |
Now, is easy to find the g = Retention rate × Profit margin × Asset turnover × Financial leverage = 5.48%
Because for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage, until it reverts to the long-run rate. In other words, a smoother transition to the mature phase growth rate that is more realistic.
Dividend growth rate (g) implied by Gordon growth model (long-run rate)
With the GGM formula and simple math:
g = (P0.r - D0)/(P0+D0)
= ($27.94 × 16.36% – $1.24) ÷ ($27.94 + $1.24) = 11.42%.
The growth rates are:
| Year | Value | g(t) |
| 1 | g(1) | 5.48% |
| 2 | g(2) | 6.96% |
| 3 | g(3) | 8.45% |
| 4 | g(4) | 9.93% |
| 5 | g(5) | 11.42% |
G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).
Now that we have all the inputs, let´s discount the cash flows to find the intrinsic value:
| Year | Value | Cash Flow | Present value |
| 0 | Div 0 | 1.24 | Â |
| 1 | Div 1 | 1.31 | 1.124 |
| 2 | Div 2 | 1.40 | 1.033 |
| 3 | Div 3 | 1.52 | 0.963 |
| 4 | Div 4 | 1.67 | 0.910 |
| 5 | Div 5 | 1.86 | 0.871 |
| 5 | Terminal Value | 41.87 | 19.629 |
| Intrinsic value | Â | Â | 24.53 |
| Current share price | Â | Â | 27.94 |
| Upside Potential | Â | Â | -12% |
Final comment
Intrinsic value is below the trading price by 12%, so according to the model and assumptions, the stock is overvalued and subject to a potential “sell” recommendation. However, we must keep in mind that the model is a valuation method and investors should not rely on it alone in order to determine a fair (over/under) value for a potential investment.
As outlined in the article, the company has been increasing dividends at a healthy rate and the dividend yield is attractive for income investors.
Hedge fund gurus like Paul Tudor Jones, Bill Frels, Ken Fisher and Martin Whitman have taken long positions in the second quarter, as well as Manning & Napier Advisors, Inc and Third Avenue Management.
Disclosure: As of this writing, Omar Venerio did not hold a position in any of the aforementioned stocks
[1] This value was obtained from the U.S. Department of the Treasury
[2] These values were obtained from Bloomberg´s CRP function.
