Does This Valuation Of Krispy Kreme, Inc. (NASDAQ:DNUT) Imply Investors Are Overpaying?

Key Insights

• Krispy Kreme's estimated fair value is US$9.41 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$12.21 suggests Krispy Kreme is potentially 30% overvalued
• The US$15.19 analyst price target for DNUT is 61% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Krispy Kreme, Inc. (NASDAQ:DNUT) by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Krispy Kreme

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, 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$64.0m	US$79.0m	US$90.3m	US$100.0m	US$108.2m	US$115.3m	US$121.4m	US$126.9m	US$131.8m	US$136.4m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 14.27%	Est @ 10.74%	Est @ 8.27%	Est @ 6.54%	Est @ 5.33%	Est @ 4.48%	Est @ 3.88%	Est @ 3.47%
Present Value ($, Millions) Discounted @ 8.9%	US$58.8	US$66.6	US$70.0	US$71.2	US$70.8	US$69.2	US$67.0	US$64.3	US$61.3	US$58.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$657m

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 (2.5%) 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)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$136m× (1 + 2.5%) ÷ (8.9%– 2.5%) = US$2.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$2.2b÷ ( 1 + 8.9%)¹⁰= US$938m

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$1.6b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$12.2, the company appears slightly overvalued 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.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Krispy Kreme 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 1.547. 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 Krispy Kreme

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. Can we work out why the company is trading at a premium to intrinsic value? For Krispy Kreme, we've compiled three essential items you should look at:

1. Risks: As an example, we've found 1 warning sign for Krispy Kreme that you need to consider before investing here.
2. Future Earnings: How does DNUT'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.

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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.