With the stock up roughly 30% in the last three months, investors may be tempted to sell their shares of Micron Technology, Inc. (NASDAQ: MU). In this article, I am going to calculate the fair value of Micron Technology by forecasting its future cash flows and discounting them back to today’s value. Value investors may find the results from my analysis surprising.
DCF Methodology
The basic philosophy behind a DCF analysis is that the intrinsic value of a company is equal to the future cash flows of that company, discounted back to present value. The general formula is provided below. The intrinsic value is considered the actual value or “true value” of an asset based on an individual’s underlying expectations and assumptions.
Cash flows into the firm in the form of revenue as the company sells its products and services, and cash flows out as it pays its cash operating expenses such as salaries or taxes (taxes are part of the definition for cash operating expenses for purposes of defining free cash flow, even though taxes aren’t generally considered a part of operating income). With the leftover cash, the firm will make short-term net investments in working capital (an example would be inventory and receivables) and longer-term investments in property, plant and equipment. The cash that remains is available to pay out to the firm’s investors: bondholders and common shareholders.
I will take you through my own expectations for Micron Technology as well as explain how I arrived at certain assumptions. The full analysis was completed on Thursday, March 8th. An updated analysis using real-time data can be viewed in your web browser at finbox.io's Micron Technology DCF analysis page. The steps involved in the valuation are:
1. Forecast Free Cash Flows
- Create a revenue forecast
- Forecast EBITDA profit margin
- Calculate free cash flow
2. Select a discount rate
3. Estimate a terminal value
4. Calculate the equity value
Step 1: Forecast Free Cash Flows
The key assumptions that have the greatest impact on cash flow projections are typically related to growth, profit margin and investments in the business. The analysis starts at the top of the income statement by creating a forecast for revenue and then works its way down to net operating profit after tax (NOPAT), as shown below.
From NOPAT, deduct cash outflows like capital expenditures and investments in net working capital and add back non-cash expenses from the income statement such as depreciation and amortization to calculate the unlevered free cash flow forecast (shown above).
Create A Revenue Forecast
When available, the finbox.io’s pre-built models use analyst forecasts as the starting assumptions. To forecast revenue, analysts gather data about the company, its customers and the state of the industry. I typically review the analysts’ forecast and modify the growth rates based on historical performance, news and other insights gathered from competitors.
Analysts covering the stock often compare the company to a peer group that includes Amkor Technology (Nasdaq: AMKR), Amtech Systems (Nasdaq: ASYS), Integrated Device Technology (Nasdaq: IDTI) and NXP Semiconductors (Nasdaq: NXPI).
The company's 5-year revenue CAGR of 19.8% is above all of its selected comparable public companies: AMKR (7.0%), ASYS (15.1%), IDTI (6.7%) and NXPI (17.8%).
As highlighted below, Micron Technology's revenue growth has ranged from -23.4% to 80.3% over the last five fiscal years.
Going forward, analysts forecast that Micron Technology's total revenue will reach $27,619 million by fiscal year 2022 representing a five-year CAGR of 6.3%.
Forecast Micron Technology's EBITDA Profit Margin
The next step is to forecast the company’s earnings before interest, taxes, depreciation and amortization (EBITDA). Note that EBITDA is a commonly used metric in valuation models because it provides a cleaner picture of overall profitability, especially when benchmarking against comparable companies. This is because it ignores non-operating costs that can be affected by certain items such as a company’s financing decisions or political jurisdictions. For more detail, see Micron Technology's EBITDA definition.
EBITDA margin is calculated by dividing EBITDA by revenue. The higher the EBITDA margin, the smaller the firm’s operating expenses are in relation to its revenue, which may ultimately lead to higher profit. Lower operating expenses for a given level of revenue can be a sign of internal economies of scale.
The charts below compare Micron Technology's LTM EBITDA margin to the same peer group. The company's EBITDA margin of 55.7% is, again, above all of its selected comparable public companies: AMKR (24.5%), ASYS (9.9%), IDTI (23.7%) and NXPI (45.7%).
Wall Street analysts are forecasting that Micron Technology's EBITDA margin will actually fall to 52.0% by fiscal year 2022, representing a decrease of -3.8% from its LTM EBITDA margin of 55.7%.
I won't specifically walk through my assumptions here, but I then forecasted depreciation & amortization, capital expenditures and net working capital based on historical levels.
Calculate Free Cash Flow
With all required forecasts in place, the next step is to calculate projected free cash flow as shown below.
Step 2: Select Micron Technology's Discount Rate
The next step is to select a discount rate to calculate the present value of the forecasted free cash flows. I used finbox.io’s Weighted Average Cost of Capital (WACC) model to help arrive at an estimate. Generally, a company’s assets are financed by either debt (debt is after tax in the formula) or equity. WACC is the average return expected by these capital providers, each weighted by respective usage. The WACC is the required return on the firm’s assets.
It’s important to note that the WACC is the appropriate discount rate to use because this analysis calculates the free cash flow available to Micron Technology’s bondholders and common shareholders. On the other hand, the cost of equity would be the appropriate discount rate if we were calculating cash flows available only to Micron Technology’s common shareholders (i.e., dividend discount model, equity DCF). This is commonly referred to as the difference between free cash flow to equity (FCFE) and free cash flow to the firm (FCFF). By using the WACC to discount FCFF, we are calculating total firm value. If we discounted FCFE at the required return on equity, we would end up with equity value of the firm. Equity value of the firm is simply total firm value minus the market value of debt.
I determined a reasonable WACC estimate for Micron Technology to be 10.5% at the midpoint. An updated cost of capital analysis using real-time data can be found at finbox.io's Micron Technology WACC Model Page. The DCF model then does the heavy lifting of calculating the discount factors by applying the mid-year convention technique.
Step 3: Estimate Micron Technology's Terminal Value
Since it is not reasonable to expect that Micron Technology will cease its operations at the end of the five-year forecast period, we must estimate the company’s continuing value, or terminal value. Terminal value is an important part of the DCF model because it accounts for the largest percentage of the calculated present value of the firm. If you were to exclude the terminal value, you would be excluding all the future cash flow past the horizon period. Using finbox.io, users can choose a five-year or 10-year horizon period to forecast future free cash flow.
The most generally accepted techniques to calculate a terminal value are by applying the Gordon growth approach, using an EBITDA exit multiple and using a revenue exit multiple. This analysis applies the Gordon growth formula:
As the formula suggests, we need to estimate a “perpetuity” growth rate at which we expect Micron Technology’s free cash flows to grow forever. Most analysts suggest that a reasonable rate is typically between the historical inflation rate of 2% to 3% and the historical GDP growth rate of 4% to 5%.
Micron Technology's free cash flows are not growing at the end of the projection period, so I’ve conservatively selected a perpetuity growth rate of 0% (at the midpoint).
An EBITDA multiple is calculated by dividing enterprise value by EBITDA. Similarly, the terminal EBITDA multiple implied from a DCF analysis is calculated by dividing the terminal value by the terminal year’s projected EBITDA. Comparing the terminal EBITDA multiple implied from the selected growth rate to benchmark multiples can serve as a useful check.
Micron Technology's implied EBITDA multiple of 5.6x seems reasonable based on its current multiple of 5.0x. This is also still well below the benchmark and sector LTM EBITDA multiple.
Step 4: Calculate Micron Technology's Equity Value
The enterprise value previously calculated is a measure of the company’s total value. An equity waterfall is a term often used by valuation firms, referring to the trickle-down process of computing a company’s equity value from its enterprise value. Note that in the event of a bankruptcy, debt holders will be paid in full before anything is distributed to common shareholders. Therefore, we must subtract debt and other financial obligations to determine a firm’s equity value. The general formula for calculating equity value is illustrated in the figure below.
The model uses the formula shown above to calculate equity value and divides the result by the shares outstanding to compute intrinsic value per share as shown at the bottom of the figure below.
The assumptions I used in the model imply an intrinsic value per share range of $64.83 to $74.10 for Micron Technology.
Micron Technology's stock price last traded at $55.24 as of Thursday, March 8th, 22.9% below my midpoint value of $67.93.
Conclusion: Micron Technology Still Has Upside Potential
A DCF analysis can seem complex at first, but it’s worth adding to your investment analysis toolbox since it provides the clearest view of company value.
Micron Technology's stock has made impressive gains over the last three months and investors may very well decide to take some chips off the table. However, the stock still appears to have some additional upside potential based on its future cash flow projections.
A DCF analysis is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only tool you use when researching a company. For Micron Technology, I’ve put together additional metrics you should look at:
Valuation: what is Micron Technology's EBITDA less CapEx multiple and how does it compare to its peers? This is a helpful multiple to analyze when comparing capital intensive businesses. View the company's EBITDA less CapEx multiple here.
Risk Metrics: how is Micron Technology's financial health? Find out by viewing our financial leverage data metric which plots the dollars in total assets for each dollar of common equity over time.
Efficiency Metrics: inventory turnover is a ratio that measures the number of times a company's inventory is sold and replaced over the year. View Micron Technology's inventory turnover here.
Author: Andy Pai
Expertise: financial modeling, mergers & acquisitions
Andy is also a founder at finbox.io, where he's focused on building tools that make it faster and easier for investors to do investment research. Andy's background is in investment banking where he led the analysis on over 50 board advisory engagements involving mergers and acquisitions, fairness opinions and solvency opinions. Some of his board advisory highlights:
- Sears Holdings Corp.'s $620 mm spin-off via rights offering of Sears Outlet, Hometown Stores and Sears Hardware Stores.
- Cerberus Capital Management's $3.3 bn acquisition of SUPERVALU Inc.'s New Albertsons, Inc. assets.
Andy can be reached at [email protected].
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.
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