Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Calavo Growers fair value estimate is US$49.51
- Calavo Growers' US$24.76 share price signals that it might be 50% undervalued
- Our fair value estimate is 49% higher than Calavo Growers' analyst price target of US$33.33
How far off is Calavo Growers, Inc. (NASDAQ:CVGW) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
The Model
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF ($, Millions) | US$19.6m | US$22.9m | US$25.7m | US$28.2m | US$30.3m | US$32.1m | US$33.6m | US$35.0m | US$36.3m | US$37.5m |
Growth Rate Estimate Source | Analyst x1 | Est @ 16.75% | Est @ 12.48% | Est @ 9.48% | Est @ 7.39% | Est @ 5.92% | Est @ 4.90% | Est @ 4.18% | Est @ 3.67% | Est @ 3.32% |
Present Value ($, Millions) Discounted @ 5.8% | US$18.5 | US$20.4 | US$21.7 | US$22.5 | US$22.8 | US$22.9 | US$22.7 | US$22.3 | US$21.9 | US$21.4 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$217m
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 (2.5%) 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 5.8%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$38m× (1 + 2.5%) ÷ (5.8%– 2.5%) = US$1.2b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.2b÷ ( 1 + 5.8%)10= US$664m
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$881m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$24.8, the company appears quite good value at a 50% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
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The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Calavo Growers 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 5.8%, which is based on a levered beta of 0.800. 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 Calavo Growers
- Debt is well covered by .
- Balance sheet summary for CVGW.
- Interest payments on debt are not well covered.
- Dividend is low compared to the top 25% of dividend payers in the Food market.
- Expected to breakeven next year.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Trading below our estimate of fair value by more than 20%.
- Debt is not well covered by operating cash flow.
- Paying a dividend but company is unprofitable.
- Revenue is forecast to decrease over the next 2 years.
- Is CVGW well equipped to handle threats?
Moving On:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Calavo Growers, there are three additional elements you should assess:
- Risks: Take risks, for example - Calavo Growers has 1 warning sign we think you should be aware of.
- Future Earnings: How does CVGW'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.