In this article we are going to estimate the intrinsic value of Andlauer Healthcare Group Inc. (TSE:AND) by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. 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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Crunching the numbers
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.
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) estimate
|Levered FCF (CA$, Millions)||CA$80.3m||CA$94.1m||CA$104.2m||CA$112.6m||CA$119.4m||CA$125.0m||CA$129.7m||CA$133.7m||CA$137.2m||CA$140.3m|
|Growth Rate Estimate Source||Analyst x5||Analyst x4||Est @ 10.73%||Est @ 7.97%||Est @ 6.05%||Est @ 4.7%||Est @ 3.75%||Est @ 3.09%||Est @ 2.63%||Est @ 2.31%|
|Present Value (CA$, Millions) Discounted @ 5.4%||CA$76.2||CA$84.8||CA$89.1||CA$91.3||CA$91.9||CA$91.3||CA$89.9||CA$87.9||CA$85.6||CA$83.2|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$871m
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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 5.4%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = CA$140m× (1 + 1.6%) ÷ (5.4%– 1.6%) = CA$3.7b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$3.7b÷ ( 1 + 5.4%)10= CA$2.2b
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 CA$3.1b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CA$49.2, the company appears quite undervalued at a 33% 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.
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 Andlauer Healthcare Group 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 5.4%, which is based on a levered beta of 0.873. 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.
Whilst important, the DCF calculation 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. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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 discount to intrinsic value? For Andlauer Healthcare Group, we've compiled three further items you should assess:
- Risks: For example, we've discovered 2 warning signs for Andlauer Healthcare Group that you should be aware of before investing here.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AND's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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 Canadian stock every day, so if you want to find the intrinsic value of any other stock just search here.
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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.