An Intrinsic Calculation For Lantronix, Inc. (NASDAQ:LTRX) Suggests It's 21% Undervalued

By
Simply Wall St
Published
November 20, 2021
NasdaqCM:LTRX
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In this article we are going to estimate the intrinsic value of Lantronix, Inc. (NASDAQ:LTRX) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Lantronix

The model

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$3.63m US$5.75m US$8.14m US$10.6m US$12.8m US$14.8m US$16.5m US$17.9m US$19.1m US$20.1m
Growth Rate Estimate Source Est @ 82.76% Est @ 58.52% Est @ 41.55% Est @ 29.67% Est @ 21.36% Est @ 15.54% Est @ 11.47% Est @ 8.61% Est @ 6.62% Est @ 5.22%
Present Value ($, Millions) Discounted @ 6.4% US$3.4 US$5.1 US$6.8 US$8.2 US$9.4 US$10.2 US$10.7 US$10.9 US$10.9 US$10.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$86m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.0%) 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 6.4%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$20m× (1 + 2.0%) ÷ (6.4%– 2.0%) = US$461m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$461m÷ ( 1 + 6.4%)10= US$248m

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$334m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$7.7, the company appears a touch undervalued at a 21% 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.

dcf
NasdaqCM:LTRX Discounted Cash Flow November 21st 2021

The 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. 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 Lantronix 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 6.4%, which is based on a levered beta of 1.014. 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:

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. 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. 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 Lantronix, there are three essential factors you should consider:

  1. Risks: For example, we've discovered 2 warning signs for Lantronix that you should be aware of before investing here.
  2. Future Earnings: How does LTRX'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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