Stock Analysis

Calculating The Fair Value Of AgroFresh Solutions, Inc. (NASDAQ:AGFS)

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NasdaqGS:AGFS
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Today we'll do a simple run through of a valuation method used to estimate the attractiveness of AgroFresh Solutions, Inc. (NASDAQ:AGFS) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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 AgroFresh Solutions

The method

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

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) US$31.0m US$31.0m US$17.0m US$13.9m US$12.3m US$11.3m US$10.8m US$10.4m US$10.3m US$10.3m
Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Est @ -18.02% Est @ -12.02% Est @ -7.82% Est @ -4.87% Est @ -2.82% Est @ -1.37% Est @ -0.36%
Present Value ($, Millions) Discounted @ 11% US$27.8 US$25.0 US$12.3 US$9.0 US$7.1 US$5.9 US$5.0 US$4.4 US$3.9 US$3.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$103m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$10m× (1 + 2.0%) ÷ (11%– 2.0%) = US$111m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$111m÷ ( 1 + 11%)10= US$38m

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$141m. 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$2.4, the company appears about fair value at a 12% 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.

dcf
NasdaqGS:AGFS Discounted Cash Flow May 16th 2021

Important 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 AgroFresh Solutions 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.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For AgroFresh Solutions, we've compiled three important elements you should further research:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with AgroFresh Solutions , and understanding this should be part of your investment process.
  2. Future Earnings: How does AGFS'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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