Calculating the intrinsic value of Freshpet, Inc. (NASDAQ:FRPT)

Key findings

• The estimated fair value of Freshpet is $121 based on 2-step free cash flow to equity

• Freshpet’s share price of $128 suggests that the price is at a similar level to the estimated fair value

• Analysts’ price target for FRPT is $138, 14% above our fair value estimate.

Does Freshpet, Inc. (NASDAQ:FRPT)’s June share price reflect its actual value? Today we’ll estimate the stock’s intrinsic value by taking the expected future cash flows and discounting them to today’s value. One way to do this is by applying the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too difficult to follow, as you’ll see from our example!

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one method. If you want to learn more about discounted cash flow, you can read the basics of this calculation in detail in Simply Wall St’s analysis model.

Check out our latest analysis for Freshpet

The model

We use the 2-stage growth model, which simply means that we consider two stages of company growth. In the early stage, the company might have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. First, we need to estimate the next ten years’ worth of cash flows. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

A DCF is all about the idea that a dollar in the future is worth less than a dollar today. Therefore, we need to discount the sum of these future cash flows to arrive at an estimate of present value:

The story goes on

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 777 million US dollars

The second phase is also called the terminal value, which is the company’s cash flow after the first phase. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.4%. We discount the terminal cash flows to today’s value at a cost of equity of 6.1%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = $328 million × (1 + 2.4%) ÷ (6.1% – 2.4%) = $9.1 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 9.1 billion US dollars ÷ (1 + 6.1%)¹⁰= 5.1 billion US dollars

Total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is $5.8 billion. To get the intrinsic value per share, we divide that by the total number of shares outstanding. Compared to the current share price of $128, the company appears to be about its fair value at the time of writing. However, keep in mind that this is only an approximate valuation and as with any complex formula, where garbage comes in, garbage comes out.

Important assumptions

The key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with these results, try the calculation yourself and play with the assumptions. DCF also doesn’t take into account the potential cyclicality of an industry or a company’s future capital needs and therefore doesn’t provide a complete picture of a company’s potential performance. Since we’re looking at Freshpet 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 takes debt into account. In this calculation, we used 6.1%, which is based on a leveraged beta of 0.800. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for Freshpet

Strength

weakness

Opportunity

Danger

Go on:

Valuation is only one side of the coin in building your investment thesis and just one of many factors you need to evaluate for a company. The DCF model is not a perfect tool for stock valuation. The best thing to do is to apply different cases and assumptions and see how they affect the company’s valuation. If a company grows differently or its cost of equity or risk-free rate changes significantly, the outcome can be very different. For Freshpet, there are three key points to look at in more detail:

1. Risks: For example, we found 1 warning sign for Freshpet that you should know before investing here.

2. Future income: How does FRPT’s growth rate compare to its competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.

3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

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

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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