Stock Analysis

Calculating The Fair Value Of Sprouts Farmers Market, Inc. (NASDAQ:SFM)

NasdaqGS:SFM
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Sprouts Farmers Market fair value estimate is US$37.84
  • Current share price of US$41.81 suggests Sprouts Farmers Market is potentially trading close to its fair value
  • Our fair value estimate is similar to Sprouts Farmers Market's analyst price target of US$37.91

How far off is Sprouts Farmers Market, Inc. (NASDAQ:SFM) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ 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.

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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Sprouts Farmers Market

Step By Step Through The Calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$192.1m US$211.6m US$180.8m US$186.2m US$184.2m US$184.0m US$185.1m US$187.1m US$189.7m US$192.9m
Growth Rate Estimate Source Analyst x4 Analyst x3 Analyst x1 Analyst x1 Est @ -1.10% Est @ -0.10% Est @ 0.59% Est @ 1.08% Est @ 1.42% Est @ 1.66%
Present Value ($, Millions) Discounted @ 6.5% US$180 US$187 US$150 US$145 US$135 US$126 US$119 US$113 US$108 US$103

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.4b

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 (2.2%) 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 6.5%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$193m× (1 + 2.2%) ÷ (6.5%– 2.2%) = US$4.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.6b÷ ( 1 + 6.5%)10= US$2.5b

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$3.8b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$41.8, 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.

dcf
NasdaqGS:SFM Discounted Cash Flow November 29th 2023

The Assumptions

We would point out that 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 Sprouts Farmers Market 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 6.5%, which is based on a levered beta of 0.850. 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 Sprouts Farmers Market

Strength
  • Debt is not viewed as a risk.
Weakness
  • Earnings growth over the past year underperformed the Consumer Retailing industry.
  • Expensive based on P/E ratio and estimated fair value.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
Threat
  • Annual earnings are forecast to grow slower than the American market.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Sprouts Farmers Market, there are three additional factors you should explore:

  1. Risks: Be aware that Sprouts Farmers Market is showing 1 warning sign in our investment analysis , you should know about...
  2. Future Earnings: How does SFM'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.

Valuation is complex, but we're helping make it simple.

Find out whether Sprouts Farmers Market is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.