Advertisement
U.S. markets open in 6 hours 25 minutes
  • S&P Futures

    5,208.25
    -6.50 (-0.12%)
     
  • Dow Futures

    39,215.00
    -8.00 (-0.02%)
     
  • Nasdaq Futures

    18,183.25
    -48.25 (-0.26%)
     
  • Russell 2000 Futures

    2,047.20
    -2.60 (-0.13%)
     
  • Crude Oil

    82.50
    -0.22 (-0.27%)
     
  • Gold

    2,159.70
    -4.60 (-0.21%)
     
  • Silver

    25.11
    -0.15 (-0.59%)
     
  • EUR/USD

    1.0868
    -0.0008 (-0.08%)
     
  • 10-Yr Bond

    4.3400
    0.0000 (0.00%)
     
  • Vix

    14.33
    -0.08 (-0.56%)
     
  • GBP/USD

    1.2706
    -0.0023 (-0.18%)
     
  • USD/JPY

    150.3090
    +1.2110 (+0.81%)
     
  • Bitcoin USD

    64,362.95
    -3,995.92 (-5.85%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • FTSE 100

    7,722.55
    -4.87 (-0.06%)
     
  • Nikkei 225

    40,003.60
    +263.20 (+0.66%)
     

Is Tower Semiconductor Ltd. (NASDAQ:TSEM) Trading At A 37% Discount?

Does the October share price for Tower Semiconductor Ltd. (NASDAQ:TSEM) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

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. 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 Tower Semiconductor

Crunching the numbers

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) forecast

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Levered FCF ($, Millions)

US$112.8m

US$133.8m

US$197.8m

US$249.5m

US$288.1m

US$321.1m

US$348.6m

US$371.6m

US$391.0m

US$407.5m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Analyst x1

Analyst x1

Est @ 15.48%

Est @ 11.43%

Est @ 8.59%

Est @ 6.6%

Est @ 5.21%

Est @ 4.23%

Present Value ($, Millions) Discounted @ 7.8%

US$105

US$115

US$158

US$185

US$198

US$204

US$206

US$204

US$199

US$192

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.8b

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.8%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$408m× (1 + 2.0%) ÷ (7.8%– 2.0%) = US$7.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$7.1b÷ ( 1 + 7.8%)10= US$3.3b

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$5.1b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$29.5, 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
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 Tower Semiconductor 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 1.179. 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.

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. 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. What is the reason for the share price sitting below the intrinsic value? For Tower Semiconductor, we've put together three additional items you should further examine:

  1. Financial Health: Does TSEM 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. Future Earnings: How does TSEM'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 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.

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.

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

Advertisement