An Intrinsic Calculation For Vital Farms, Inc. (NASDAQ:VITL) Suggests It's 37% Undervalued

Key Insights

• Vital Farms' estimated fair value is US$23.18 based on 2 Stage Free Cash Flow to Equity

• Vital Farms' US$14.69 share price signals that it might be 37% undervalued

• Our fair value estimate is 20% higher than Vital Farms' analyst price target of US$19.29

Today we will run through one way of estimating the intrinsic value of Vital Farms, Inc. (NASDAQ:VITL) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

See our latest analysis for Vital Farms

Step By Step Through The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	-US$1.67m	US$5.28m	US$10.5m	US$17.9m	US$26.8m	US$36.2m	US$45.5m	US$53.8m	US$61.1m	US$67.2m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 99.27%	Est @ 70.11%	Est @ 49.70%	Est @ 35.41%	Est @ 25.41%	Est @ 18.41%	Est @ 13.51%	Est @ 10.07%
Present Value ($, Millions) Discounted @ 6.8%	-US$1.6	US$4.6	US$8.6	US$13.7	US$19.2	US$24.4	US$28.6	US$31.7	US$33.7	US$34.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$198m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 6.8%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$67m× (1 + 2.1%) ÷ (6.8%– 2.1%) = US$1.4b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.4b÷ ( 1 + 6.8%)¹⁰= US$747m

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$944m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$14.7, the company appears quite good value at a 37% discount to where the stock price trades currently. 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.

dcf

Important 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 Vital Farms 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 6.8%, 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 Vital Farms

Strength

• Currently debt free.

Weakness

• Earnings declined over the past year.

Opportunity

• Annual earnings are forecast to grow faster than the American market.

• Trading below our estimate of fair value by more than 20%.

Threat

• Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For Vital Farms, we've put together three pertinent aspects you should explore:

1. Risks: For example, we've discovered 2 warning signs for Vital Farms (1 shouldn't be ignored!) that you should be aware of before investing here.

2. Future Earnings: How does VITL'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.

3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGM every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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