Is Krispy Kreme, Inc. (NASDAQ:DNUT) Trading At A 27% Discount?

Key Insights

• The projected fair value for Krispy Kreme is US$6.88 based on 2 Stage Free Cash Flow to Equity
• Krispy Kreme's US$5.00 share price signals that it might be 27% undervalued
• Our fair value estimate is 40% lower than Krispy Kreme's analyst price target of US$11.43

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Krispy Kreme, Inc. (NASDAQ:DNUT) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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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. 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.

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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$59.0m	US$75.0m	US$90.0m	US$101.3m	US$111.0m	US$119.4m	US$126.7m	US$133.1m	US$139.0m	US$144.4m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 12.54%	Est @ 9.60%	Est @ 7.55%	Est @ 6.11%	Est @ 5.10%	Est @ 4.40%	Est @ 3.90%
Present Value ($, Millions) Discounted @ 11%	US$53.0	US$60.4	US$65.1	US$65.7	US$64.7	US$62.4	US$59.5	US$56.1	US$52.6	US$49.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$588m

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 (2.8%) 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 11%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$144m× (1 + 2.8%) ÷ (11%– 2.8%) = US$1.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.7b÷ ( 1 + 11%)¹⁰= US$582m

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$1.2b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$5.0, the company appears a touch undervalued at a 27% discount to where the stock price trades currently. 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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 11%, which is based on a levered beta of 2.000. 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.

See our latest analysis for Krispy Kreme

SWOT Analysis for Krispy Kreme

Next Steps:

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. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Krispy Kreme, we've compiled three important elements you should consider:

1. Risks: For instance, we've identified 3 warning signs for Krispy Kreme (2 make us uncomfortable) you should be aware of.
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.