Stitch Fix, Inc.'s (NASDAQ:SFIX) Intrinsic Value Is Potentially 99% Above Its Share Price

Key Insights

• The projected fair value for Stitch Fix is US$4.54 based on 2 Stage Free Cash Flow to Equity

• Stitch Fix is estimated to be 50% undervalued based on current share price of US$2.28

• The US$3.29 analyst price target for SFIX is 28% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Stitch Fix, Inc. (NASDAQ:SFIX) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 Stitch Fix

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. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$6.65m	US$17.0m	US$26.0m	US$21.0m	US$32.0m	US$36.0m	US$39.4m	US$42.2m	US$44.7m	US$46.8m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x2	Analyst x1	Analyst x1	Est @ 12.43%	Est @ 9.42%	Est @ 7.31%	Est @ 5.83%	Est @ 4.79%
Present Value ($, Millions) Discounted @ 8.4%	US$6.1	US$14.4	US$20.4	US$15.2	US$21.4	US$22.2	US$22.4	US$22.2	US$21.7	US$21.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$187m

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 (2.4%) 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 8.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$47m× (1 + 2.4%) ÷ (8.4%– 2.4%) = US$801m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$801m÷ ( 1 + 8.4%)¹⁰= US$359m

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$546m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$2.3, the company appears quite undervalued at a 50% 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

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 Stitch Fix 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 8.4%, which is based on a levered beta of 1.301. 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 Stitch Fix

Strength

• Currently debt free.

Weakness

• Shareholders have been diluted in the past year.

Opportunity

• Forecast to reduce losses next year.

• Has sufficient cash runway for more than 3 years based on current free cash flows.

• Good value based on P/S ratio and estimated fair value.

Threat

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

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For Stitch Fix, there are three fundamental items you should further examine:

1. Risks: Be aware that Stitch Fix is showing 2 warning signs in our investment analysis , you should know about...

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SFIX'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. 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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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.