Are Chewy, Inc. (NYSE:CHWY) Investors Paying Above The Intrinsic Value?

Chewy -4.85%

Chewy

CHWY

17.64

-4.85%

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Chewy fair value estimate is US$20.22
  • Chewy's US$24.60 share price signals that it might be 22% overvalued
  • Analyst price target for CHWY is US$25.22, which is 25% above our fair value estimate

In this article we are going to estimate the intrinsic value of Chewy, Inc. (NYSE:CHWY) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

View our latest analysis for Chewy

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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$293.3m US$309.5m US$385.8m US$428.1m US$463.9m US$494.1m US$519.9m US$542.3m US$562.3m US$580.6m
Growth Rate Estimate Source Analyst x8 Analyst x8 Analyst x6 Est @ 10.97% Est @ 8.35% Est @ 6.51% Est @ 5.22% Est @ 4.32% Est @ 3.69% Est @ 3.25%
Present Value ($, Millions) Discounted @ 7.4% US$273 US$269 US$312 US$322 US$325 US$323 US$316 US$307 US$297 US$286

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.0b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$581m× (1 + 2.2%) ÷ (7.4%– 2.2%) = US$12b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$12b÷ ( 1 + 7.4%)10= US$5.7b

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$8.7b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$24.6, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NYSE:CHWY Discounted Cash Flow December 29th 2023

Important Assumptions

Now 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 Chewy 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 7.4%, which is based on a levered beta of 1.026. 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 Chewy

Strength
  • Currently debt free.
Weakness
  • Expensive based on P/S ratio and estimated fair value.
Opportunity
  • Annual earnings are forecast to grow faster than the American market.
  • Significant insider buying over the past 3 months.
Threat
  • Annual revenue is forecast to grow slower than the American market.

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 lower than the current share price? For Chewy, we've put together three important factors you should consider:

  1. Financial Health: Does CHWY have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does CHWY'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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