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Is KLA Corporation (NASDAQ:KLAC) Worth US$745 Based On Its Intrinsic Value?

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, KLA fair value estimate is US$591

  • KLA is estimated to be 26% overvalued based on current share price of US$745

  • The US$859 analyst price target for KLAC is 45% more than our estimate of fair value

How far off is KLA Corporation (NASDAQ:KLAC) 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. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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.

View our latest analysis for KLA

The Calculation

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

Levered FCF ($, Millions)

US$3.91b

US$4.44b

US$4.55b

US$4.73b

US$4.88b

US$5.03b

US$5.18b

US$5.32b

US$5.46b

US$5.61b

Growth Rate Estimate Source

Analyst x8

Analyst x6

Analyst x3

Analyst x1

Est @ 3.27%

Est @ 3.04%

Est @ 2.88%

Est @ 2.76%

Est @ 2.69%

Est @ 2.63%

Present Value ($, Millions) Discounted @ 8.1%

US$3.6k

US$3.8k

US$3.6k

US$3.5k

US$3.3k

US$3.2k

US$3.0k

US$2.9k

US$2.7k

US$2.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$32b

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. 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 (2.5%) 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 8.1%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$5.6b× (1 + 2.5%) ÷ (8.1%– 2.5%) = US$103b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$103b÷ ( 1 + 8.1%)10= US$47b

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$79b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$745, the company appears slightly overvalued at the time of writing. 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
dcf

The Assumptions

Now 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 KLA 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 8.1%, which is based on a levered beta of 1.355. 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 KLA

Strength

  • Debt is well covered by earnings and cashflows.

Weakness

  • Earnings declined over the past year.

  • Dividend is low compared to the top 25% of dividend payers in the Semiconductor market.

  • Expensive based on P/E ratio and estimated fair value.

Opportunity

  • Annual revenue is forecast to grow faster than the American market.

Threat

  • Annual earnings are forecast to grow slower than the American market.

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. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a premium to intrinsic value? For KLA, there are three further factors you should assess:

  1. Risks: Every company has them, and we've spotted 1 warning sign for KLA you should know about.

  2. Future Earnings: How does KLAC'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.

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.