Calculating The Fair Value Of Varex Imaging Corporation (NASDAQ:VREX)

Using the 2 Stage Free Cash Flow to Equity, Varex Imaging fair value estimate is US$8.11
Varex Imaging's US$7.67 share price indicates it is trading at similar levels as its fair value estimate
The US$16.60 analyst price target for VREX is 105% more than our estimate of fair value
How far off is Varex Imaging Corporation (NASDAQ:VREX) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
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We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF ($, Millions)
US$24.9m
US$46.8m
US$39.5m
US$35.5m
US$33.3m
US$32.1m
US$31.6m
US$31.6m
US$31.8m
US$32.3m
Growth Rate Estimate Source
Analyst x1
Analyst x1
Est @ -15.68%
Est @ -10.10%
Est @ -6.19%
Est @ -3.45%
Est @ -1.53%
Est @ -0.19%
Est @ 0.75%
Est @ 1.41%
Present Value ($, Millions) Discounted @ 11%
US$22.4
US$37.8
US$28.6
US$23.1
US$19.5
US$16.9
US$15.0
US$13.4
US$12.2
US$11.1
("Est" = FCF growth rate estimated by Simply Wall St)Present Value of 10-year Cash Flow (PVCF) = US$200m
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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 11%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$32m× (1 + 2.9%) ÷ (11%– 2.9%) = US$398m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$398m÷ ( 1 + 11%)10= US$137m
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$337m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$7.7, the company appears about fair value at a 5.5% 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Varex Imaging 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 11%, which is based on a levered beta of 1.925. 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.
View our latest analysis for Varex Imaging
Strength
No major strengths identified for VREX.
Weakness
Interest payments on debt are not well covered.
Opportunity
Expected to breakeven 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
Debt is not well covered by operating cash flow.
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. For Varex Imaging, we've compiled three important items you should consider:
Risks: Every company has them, and we've spotted 2 warning signs for Varex Imaging (of which 1 is potentially serious!) you should know about.
Future Earnings: How does VREX'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.
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.
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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