An Intrinsic Calculation For Coherent Corp. (NYSE:COHR) Suggests It's 25% Undervalued

Coherent, Inc. +2.19%
 Coherent, Inc. COHR 63.34 +2.19%

### Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Coherent fair value estimate is US\$96.44
• Coherent is estimated to be 25% undervalued based on current share price of US\$72.46
• The US\$67.00 analyst price target for COHR is 31% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Coherent Corp. (NYSE:COHR) by taking the expected future cash flows and discounting them to today's 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!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

## Step By Step Through The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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 discount the value of these future cash flows to their estimated value in today's dollars:

#### 10-year free cash flow (FCF) forecast

 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (\$, Millions) US\$69.7m US\$350.7m US\$536.3m US\$717.0m US\$855.3m US\$976.9m US\$1.08b US\$1.17b US\$1.24b US\$1.31b Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x3 Analyst x1 Est @ 19.29% Est @ 14.22% Est @ 10.67% Est @ 8.18% Est @ 6.44% Est @ 5.22% Present Value (\$, Millions) Discounted @ 8.4% US\$64.2 US\$298 US\$421 US\$518 US\$570 US\$601 US\$613 US\$611 US\$600 US\$582

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US\$4.9b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 8.4%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US\$1.3b× (1 + 2.4%) ÷ (8.4%– 2.4%) = US\$22b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US\$22b÷ ( 1 + 8.4%)10= US\$9.8b

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\$15b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US\$72.5, the company appears a touch undervalued at a 25% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

## 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Coherent 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 1.319. 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 Coherent

Strength
• No major strengths identified for COHR.
Weakness
• Interest payments on debt are not well covered.
• 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.
• Trading below our estimate of fair value by more than 20%.
Threat
• Debt is not well covered by operating cash flow.