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Calculating The Fair Value Of Treace Medical Concepts, Inc. (NASDAQ:TMCI)

Key Insights

  • Treace Medical Concepts' estimated fair value is US$26.10 based on 2 Stage Free Cash Flow to Equity

  • Current share price of US$25.97 suggests Treace Medical Concepts is potentially trading close to its fair value

  • The US$30.17 analyst price target for TMCI is 16% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Treace Medical Concepts, Inc. (NASDAQ:TMCI) 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

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View our latest analysis for Treace Medical Concepts

The Method

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

-US$45.9m

-US$29.7m

-US$14.0m

US$26.0m

US$50.0m

US$70.7m

US$91.6m

US$111.1m

US$128.4m

US$143.2m

Growth Rate Estimate Source

Analyst x3

Analyst x3

Analyst x2

Analyst x1

Analyst x1

Est @ 41.33%

Est @ 29.56%

Est @ 21.33%

Est @ 15.56%

Est @ 11.53%

Present Value ($, Millions) Discounted @ 7.5%

-US$42.7

-US$25.7

-US$11.3

US$19.5

US$34.9

US$45.8

US$55.3

US$62.4

US$67.1

US$69.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$275m

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 (2.1%) 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 7.5%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$143m× (1 + 2.1%) ÷ (7.5%– 2.1%) = US$2.7b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.7b÷ ( 1 + 7.5%)10= US$1.3b

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$1.6b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$26.0, the company appears about fair value at a 0.5% 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
dcf

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. 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 Treace Medical Concepts 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 0.904. 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.

SWOT Analysis for Treace Medical Concepts

Strength

  • Debt is well covered by earnings.

Weakness

  • Shareholders have been diluted in the past year.

Opportunity

  • Current share price is below our estimate of fair value.

Threat

  • Debt is not well covered by operating cash flow.

  • Has less than 3 years of cash runway based on current free cash flow.

  • Not expected to become profitable over the next 3 years.

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Treace Medical Concepts, we've put together three important aspects you should further research:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Treace Medical Concepts , and understanding them should be part of your investment process.

  2. Future Earnings: How does TMCI'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 NASDAQGS every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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