Stock Analysis

Is There An Opportunity With Patrick Industries, Inc.'s (NASDAQ:PATK) 32% Undervaluation?

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NasdaqGS:PATK
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Key Insights

  • Patrick Industries' estimated fair value is US$99.2 based on 2 Stage Free Cash Flow to Equity
  • Current share price of US$67.7 suggests Patrick Industries is 32% undervalued
  • Analyst price target for PATK is US$65.33 which is 34% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Patrick Industries, Inc. (NASDAQ:PATK) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Patrick Industries

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. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$315.7m US$293.1m US$280.9m US$274.3m US$271.5m US$271.1m US$272.5m US$275.0m US$278.5m US$282.6m
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ -4.18% Est @ -2.33% Est @ -1.04% Est @ -0.13% Est @ 0.50% Est @ 0.95% Est @ 1.26% Est @ 1.47%
Present Value ($, Millions) Discounted @ 13% US$279 US$228 US$193 US$166 US$145 US$128 US$113 US$101 US$90.2 US$80.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.5b

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 13%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$283m× (1 + 2.0%) ÷ (13%– 2.0%) = US$2.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.5b÷ ( 1 + 13%)10= US$724m

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$2.2b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$67.7, the company appears quite undervalued at a 32% 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.

dcf
NasdaqGS:PATK Discounted Cash Flow January 25th 2023

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Patrick Industries 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 13%, which is based on a levered beta of 1.892. 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 Patrick Industries

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Dividend is low compared to the top 25% of dividend payers in the Auto Components market.
Opportunity
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Annual earnings are forecast to decline for the next 3 years.

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. 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For Patrick Industries, we've put together three relevant elements you should explore:

  1. Risks: As an example, we've found 3 warning signs for Patrick Industries (1 is significant!) that you need to consider before investing here.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for PATK's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.

Valuation is complex, but we're helping make it simple.

Find out whether Patrick Industries is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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