Estimating The Fair Value Of Culp, Inc. (NYSE:CULP)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Culp fair value estimate is US$4.08
• Current share price of US$4.29 suggests Culp is potentially trading close to its fair value
• Industry average of 38% suggests Culp's peers are currently trading at a higher premium to fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Culp, Inc. (NYSE:CULP) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for Culp

The Calculation

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 start off with, we need to estimate 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.

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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$1.97m	-US$4.89m	US$1.40m	US$2.09m	US$2.84m	US$3.56m	US$4.21m	US$4.78m	US$5.26m	US$5.67m
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x2	Est @ 49.66%	Est @ 35.39%	Est @ 25.41%	Est @ 18.42%	Est @ 13.53%	Est @ 10.10%	Est @ 7.70%
Present Value ($, Millions) Discounted @ 8.9%	US$1.8	-US$4.1	US$1.1	US$1.5	US$1.9	US$2.1	US$2.3	US$2.4	US$2.4	US$2.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$14m

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 8.9%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$5.7m× (1 + 2.1%) ÷ (8.9%– 2.1%) = US$85m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$85m÷ ( 1 + 8.9%)¹⁰= US$36m

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$50m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$4.3, the company appears around fair value at the time of writing. 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.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Culp 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 1.143. 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.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Culp, we've compiled three important factors you should consider:

1. Risks: Case in point, we've spotted 1 warning sign for Culp you should be aware of.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CULP's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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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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.