Stock Analysis

Is There An Opportunity With Crocs, Inc.'s (NASDAQ:CROX) 45% Undervaluation?

  •  Updated
NasdaqGS:CROX
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Today we will run through one way of estimating the intrinsic value of Crocs, Inc. (NASDAQ:CROX) by projecting its future cash flows and then discounting them to today's value. This will be done using 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 the opportunities and risks within the US Luxury industry.

The Model

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 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$661.8m US$564.2m US$655.2m US$771.2m US$809.9m US$843.1m US$872.4m US$898.7m US$923.0m US$946.0m
Growth Rate Estimate Source Analyst x5 Analyst x3 Analyst x2 Analyst x1 Est @ 5.02% Est @ 4.1% Est @ 3.47% Est @ 3.02% Est @ 2.71% Est @ 2.49%
Present Value ($, Millions) Discounted @ 8.9% US$608 US$476 US$508 US$549 US$530 US$506 US$481 US$456 US$430 US$405

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.9b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.9%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$946m× (1 + 2.0%) ÷ (8.9%– 2.0%) = US$14b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$14b÷ ( 1 + 8.9%)10= US$6.0b

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$11b. 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$96.6, the company appears quite good value at a 45% discount to where the stock price trades currently. 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.

dcf
NasdaqGS:CROX Discounted Cash Flow November 25th 2022

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 Crocs 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 8.9%, which is based on a levered beta of 1.342. 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 Crocs

Strength
  • Debt is well covered by earnings.
Weakness
  • Earnings declined over the past year.
  • Shareholders have been diluted in the past year.
Opportunity
  • Annual revenue is forecast to grow faster than the American market.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Annual earnings are forecast to grow slower than the American market.

Moving On:

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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Crocs, there are three important factors you should look at:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Crocs (at least 1 which is significant) , and understanding these should be part of your investment process.
  2. Future Earnings: How does CROX'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.

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