Stock Analysis

Are Investors Undervaluing CarParts.com, Inc. (NASDAQ:PRTS) By 30%?

  •  Updated
NasdaqGS:PRTS
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Does the April share price for CarParts.com, Inc. (NASDAQ:PRTS) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for CarParts.com

The method

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) -US$5.36m US$2.35m US$14.5m US$29.6m US$44.6m US$56.6m US$67.5m US$77.1m US$85.2m US$92.0m
Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Analyst x1 Analyst x1 Est @ 26.77% Est @ 19.35% Est @ 14.16% Est @ 10.52% Est @ 7.98%
Present Value ($, Millions) Discounted @ 7.5% -US$5.0 US$2.0 US$11.7 US$22.1 US$31.1 US$36.6 US$40.7 US$43.2 US$44.4 US$44.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$271m

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 7.5%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$92m× (1 + 2.0%) ÷ (7.5%– 2.0%) = US$1.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.7b÷ ( 1 + 7.5%)10= US$830m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$1.1b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$16.1, the company appears a touch undervalued at a 30% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NasdaqGS:PRTS Discounted Cash Flow April 19th 2021

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 CarParts.com 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 7.5%, which is based on a levered beta of 1.047. 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.

Moving On:

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. It's not possible to obtain a foolproof valuation with a DCF model. 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For CarParts.com, we've compiled three pertinent factors you should consider:

  1. Risks: Every company has them, and we've spotted 3 warning signs for CarParts.com you should know about.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for PRTS's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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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