Estimating The Fair Value Of Cree Inc (NASDAQ:CREE)

Does the share price for Cree Inc (NASDAQ:CREE) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by estimating the company’s future cash flows and discounting them to their present value. I will be using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in June 2018 so be sure check out the updated calculation by following the link below. View out our latest analysis for Cree

The method

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 five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow estimate

2018	2019	2020	2021	2022
Levered FCF ($, Millions)	$-32.80	$39.04	$120.81	$234.00	$412.66
Source	Analyst x3	Analyst x2	Analyst x3	Analyst x1	Analyst x1
Present Value Discounted @ 10.26%	$-29.75	$32.11	$90.13	$158.33	$253.25

Present Value of 5-year Cash Flow (PVCF)= US$504.08m

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 10.3%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = US$412.66m × (1 + 2.9%) ÷ (10.3% – 2.9%) = US$5.81b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = US$5.81b ÷ ( 1 + 10.3%)⁵ = US$3.57b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$4.07b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of $40.89. Relative to the current share price of $48.58, the stock is fair value, maybe slightly overvalued at the time of writing.

NasdaqGS:CREE Intrinsic Value June 24th 18

Important assumptions

I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Cree as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 10.3%, which is based on a levered beta of 1.037. This is derived from the Bottom-Up Beta method based on 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.

For CREE, there are three key factors you should look at:

1. Financial Health: Does CREE 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 CREE’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: Are there other high quality stocks you could be holding instead of CREE? 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 for every stock on the NASDAQ every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.