Is There An Opportunity With a.k.a. Brands Holding Corp.'s (NYSE:AKA) 49% Undervaluation?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, a.k.a. Brands Holding fair value estimate is US$0.99
• a.k.a. Brands Holding's US$0.51 share price signals that it might be 49% undervalued
• The US$1.58 analyst price target for AKA is 59% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of a.k.a. Brands Holding Corp. (NYSE:AKA) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. 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.

See our latest analysis for a.k.a. Brands Holding

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. To begin with, we have to get estimates of 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$34.4m	US$23.8m	US$18.4m	US$15.6m	US$14.0m	US$13.1m	US$12.6m	US$12.3m	US$12.2m	US$12.2m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ -22.78%	Est @ -15.31%	Est @ -10.08%	Est @ -6.43%	Est @ -3.86%	Est @ -2.07%	Est @ -0.82%	Est @ 0.06%
Present Value ($, Millions) Discounted @ 14%	US$30.2	US$18.3	US$12.4	US$9.2	US$7.3	US$6.0	US$5.0	US$4.3	US$3.8	US$3.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$100m

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 14%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$12m× (1 + 2.1%) ÷ (14%– 2.1%) = US$105m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$105m÷ ( 1 + 14%)¹⁰= US$28m

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$128m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$0.5, the company appears quite good value at a 49% discount to where the stock price trades currently. 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.

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. 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 a.k.a. Brands Holding 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 14%, 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.

Moving On:

Although the valuation of a company is important, 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For a.k.a. Brands Holding, we've compiled three relevant aspects you should assess:

1. Risks: You should be aware of the 2 warning signs for a.k.a. Brands Holding (1 makes us a bit uncomfortable!) we've uncovered before considering an investment in the company.
2. Future Earnings: How does AKA'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 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 NYSE 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.