U.S. Markets closed

A Look At The Intrinsic Value Of Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF)

Simply Wall St

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

In this article we are going to estimate the intrinsic value of Rocky Mountain Chocolate Factory, Inc. (NASDAQ:RMCF) by taking the expected future cash flows and discounting them to today's value. I will be using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Rocky Mountain Chocolate Factory

The calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

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

2019 2020 2021 2022 2023 2024 2025 2026 2027 2028
Levered FCF ($, Millions) $2.94 $2.75 $2.65 $2.61 $2.60 $2.61 $2.64 $2.69 $2.74 $2.80
Growth Rate Estimate Source Est @ -10.18% Est @ -6.31% Est @ -3.6% Est @ -1.7% Est @ -0.37% Est @ 0.56% Est @ 1.21% Est @ 1.67% Est @ 1.99% Est @ 2.21%
Present Value ($, Millions) Discounted @ 7.5% $2.73 $2.38 $2.13 $1.95 $1.81 $1.69 $1.59 $1.51 $1.43 $1.36

Present Value of 10-year Cash Flow (PVCF)= $18.59m

"Est" = FCF growth rate estimated by Simply Wall St

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 10-year government bond rate of 2.7%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.

Terminal Value (TV) = FCF2029 × (1 + g) ÷ (r – g) = US$2.8m × (1 + 2.7%) ÷ (7.5% – 2.7%) = US$60m

Present Value of Terminal Value (PVTV) = TV / (1 + r)10 = $US$60m ÷ ( 1 + 7.5%)10 = $29.28m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is $47.87m. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value estimate of $8.03. Relative to the current share price of $8.37, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

NasdaqGM:RMCF Intrinsic value, June 25th 2019

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. 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 Rocky Mountain Chocolate Factory 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 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.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/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. For Rocky Mountain Chocolate Factory, I've compiled three further aspects you should look at:

  1. Financial Health: Does RMCF have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of RMCF? 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 NASDAQ every day. If you want to find the calculation for other stocks just search here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.