Calculating The Intrinsic Value Of Arhaus, Inc. (NASDAQ:ARHS)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Arhaus fair value estimate is US$11.28
With US$12.83 share price, Arhaus appears to be trading close to its estimated fair value
Analyst price target for ARHS is US$13.55, which is 20% above our fair value estimate
Today we will run through one way of estimating the intrinsic value of Arhaus, Inc. (NASDAQ:ARHS) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Arhaus
Crunching The Numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$51.6m | US$90.3m | US$90.9m | US$91.9m | US$93.3m | US$94.9m | US$96.7m | US$98.6m | US$100.7m | US$102.9m |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Est @ 0.66% | Est @ 1.15% | Est @ 1.49% | Est @ 1.73% | Est @ 1.90% | Est @ 2.02% | Est @ 2.10% | Est @ 2.16% |
Present Value ($, Millions) Discounted @ 7.5% | US$48.0 | US$78.1 | US$73.1 | US$68.8 | US$64.9 | US$61.4 | US$58.2 | US$55.2 | US$52.4 | US$49.8 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$610m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 (2.3%) 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 7.5%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$103m× (1 + 2.3%) ÷ (7.5%– 2.3%) = US$2.0b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.0b÷ ( 1 + 7.5%)10= US$973m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$1.6b. 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$12.8, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Important Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Arhaus 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 7.5%, which is based on a levered beta of 1.138. 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 Arhaus
Strength
Earnings growth over the past year exceeded the industry.
Currently debt free.
Weakness
Earnings growth over the past year is below its 5-year average.
Expensive based on P/E ratio and estimated fair value.
Opportunity
ARHS' financial characteristics indicate limited near-term opportunities for shareholders.
Threat
Annual earnings are forecast to decline for the next 4 years.
Looking Ahead:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Arhaus, we've compiled three additional factors you should explore:
Risks: Every company has them, and we've spotted 3 warning signs for Arhaus (of which 2 are a bit unpleasant!) you should know about.
Future Earnings: How does ARHS'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks 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.
