A Look At The Fair Value Of CSP Inc. (NASDAQ:CSPI)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, CSP fair value estimate is US$26.81
CSP's US$21.55 share price indicates it is trading at similar levels as its fair value estimate
Peers of CSP are currently trading on average at a 38% premium
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of CSP Inc. (NASDAQ:CSPI) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
See our latest analysis for CSP
Crunching The Numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$4.64m | US$5.50m | US$6.25m | US$6.89m | US$7.44m | US$7.89m | US$8.29m | US$8.63m | US$8.94m | US$9.22m |
Growth Rate Estimate Source | Est @ 25.62% | Est @ 18.60% | Est @ 13.69% | Est @ 10.25% | Est @ 7.84% | Est @ 6.15% | Est @ 4.97% | Est @ 4.15% | Est @ 3.57% | Est @ 3.16% |
Present Value ($, Millions) Discounted @ 7.8% | US$4.3 | US$4.7 | US$5.0 | US$5.1 | US$5.1 | US$5.0 | US$4.9 | US$4.7 | US$4.5 | US$4.3 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$48m
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. 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.8%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$9.2m× (1 + 2.2%) ÷ (7.8%– 2.2%) = US$168m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$168m÷ ( 1 + 7.8%)10= US$79m
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$127m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$21.6, the company appears about fair value at a 20% 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.
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 CSP 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 7.8%, which is based on a levered beta of 1.122. 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 CSP
Strength
Earnings growth over the past year exceeded the industry.
Debt is not viewed as a risk.
Weakness
Dividend is low compared to the top 25% of dividend payers in the IT market.
Shareholders have been diluted in the past year.
Opportunity
Current share price is below our estimate of fair value.
Significant insider buying over the past 3 months.
Lack of analyst coverage makes it difficult to determine CSPI's earnings prospects.
Threat
No apparent threats visible for CSPI.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For CSP, there are three fundamental aspects you should further examine:
Risks: As an example, we've found 2 warning signs for CSP that you need to consider before investing here.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CSPI's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.
